Educational Expenses and Benefits

This year, you may have received Form 1098-T (Tuition Statement).  This form will show the amount of the tuition that was billed by the institution - and does NOT include all of the other "qualified" expenses that you may have paid. 

By the way, the IRS's position regarding 1098-T is that it is not acceptable documentation for educational expenses.  Some taxpayers mistakenly believe the form serves as a record of educational expenses paid.  However, the form, issued by universities, only documents tuition that the school billed, not what the student paid. Taxpayers who don’t keep good records of their education expenses could be robbing themselves of money.

There are two education tax credits available  the Hope Credit and the Lifetime Learning Credit.

This is a reprint from information the IRS added to their website in 2006:

The $1,500 HOPE Scholarship credit is designed to make the first two years of college universally available. For students in the first two years of college (or other eligible post-secondary training), taxpayers will be eligible for a tax credit equal to 100% of the first $1,000 of tuition and fees and 50% of the second $1,000 (the amounts are indexed for inflation after 2001).

The maximum amount of Hope credit you can claim is $1,500 times the number of eligible students. You can claim the full $1,500 for each eligible student for whom you paid at least $2,000 of qualified education expenses. However, the credit may be reduced based on your modified adjusted gross income (MAGI), discussed later.

Generally, you can claim the Hope credit if all three of the following requirements are met.

You cannot claim the Hope credit if any of the following apply.

The credit will be available on a per-student basis for net tuition and fees (less grant aid) paid for college enrollment.  The credit can be claimed in two taxable years (but not beyond the year when the student completes the first two years of college) with respect to any individual enrolled on at least a half-time basis for any portion of the year.

You can claim a Hope Credit only for an "eligible student." An "eligible student" is a student who:

• As of the beginning of the year, has not completed the first two years of post–secondary education (that is, generally is a freshman or sophomore in college).

• Is enrolled in a program that leads to a degree, certificate, or other recognized educational credential, for at least one academic period beginning during the year.

• Is taking at least one–half of the normal full–time workload for the student's course of study for at least one academic period beginning during the calendar year, and

• Is free of any federal or state felony conviction for possessing or distributing a controlled substance as of the end of the year.

You can claim a Hope credit for qualified education expenses paid with the proceeds of a loan. You use the expenses to figure the Hope credit for the year in which the expenses are paid, not the year in which the loan is repaid. Treat loan payments sent directly to the educational institution as paid on the date the institution credits the student's account.

If you claim an exemption for a dependent who is an eligible student, only you can include any expenses you paid when figuring the amount of the Hope credit. If neither you nor anyone else claims an exemption for the dependent, only the dependent can include any expenses you paid when figuring the Hope credit.

If you receive a refund of any education expenses, it may have to be reported (or reduce the credit if received in the same year).  Read IRS Publication 970 for more information on how to treat any refund received.

If you are eligible to claim the Hope credit and you are also eligible to claim the lifetime learning credit for the same student in the same year, you can choose to claim either credit, but not both. For 2005 and 2006, if the total qualified education expenses for a student are less than $7,500, it will generally be to your benefit to claim the Hope credit.

If you pay qualified education expenses for more than one student in the same year, you can choose to take credits on a per-student, per-year basis. This means that, for example, you can claim the Hope credit for one student and the lifetime learning credit for another student in the same year.

You may be able to claim a lifetime learning credit of up to $2,000 for qualified education expenses paid for all students enrolled in eligible educational institutions. There is no limit on the number of years the lifetime learning credit can be claimed for each student.

The Lifetime Learning Credit is for College Juniors, Seniors, Graduate Students and working Americans pursuing lifelong learning to upgrade their skills. For those beyond the first two years of college, or taking classes part-time to improve or upgrade their job skills, the family will receive a 20% tax credit. 

Beginning in 2003, the amount of qualified education expenses you can take into account in figuring your lifetime learning credit increased from $5,000 to $10,000. The credit will equal 20% of these qualified expenses, with the maximum credit being $2,000.  The credit is available for net tuition and fees (less grant aid) paid for post-secondary enrollment. The credit is available on a per-taxpayer (family) basis, and is phased out at the same income levels as the HOPE Scholarship.

The credits are based on education expenses paid for you, your spouse, or your dependents. During any particular year, you can claim only one of the credits for each student.

The amount of the credit is determined by the amount you pay for "qualified tuition and related expenses" for each student and the amount of your modified adjusted gross income (modified AGI).

Expenses that qualify are tuition and fees required for enrollment or attendance at an accredited college, university, vocational school, or other post–secondary educational institution that is eligible to participate in a student aid program administered by the Department of Education.

Qualified expenses do not include room and board, insurance, transportation, or other similar personal, living, or family expenses. Qualified expenses may include fees for books, supplies, and equipment only if the fees must be paid to the school for the student's enrollment or attendance. In addition, qualified expenses may include student activity fees if the fee must be paid to the school for the student's enrollment or attendance.

For 2005, the amount of your interest exclusion will be phased out (gradually reduced) if your filing status is married filing jointly or qualifying widow(er) and your modified adjusted gross income (MAGI) is between 91,850 and $121,850. You cannot take the deduction if your MAGI is $121,850 or more. For all other filing statuses, your interest exclusion is phased out if your MAGI is between $61,200 and $76,200. You cannot take the deduction if your MAGI is $76,200 or more.

Tuition and fees deduction 

Beginning in 2005, the amount of qualified education expenses you can take into account in figuring your tuition and fees deduction is $4,000 if your modified adjusted gross income (MAGI) is not more than $65,000 ($130,000 if you are married filing jointly). If your MAGI is larger than $65,000 ($130,000), but is not more than $80,000 ($160,000 if you are married filing jointly), your maximum tuition and fees deduction will be $2,000. No tuition and fees deduction will be allowed if your MAGI is larger than $80,000 ($160,000).

NOTE:  This information is taken from the IRS web site and included here for your convenience.

A Coverdell Education Savings Account (ESA) is a savings account created as an incentive to help parents and students save for education expenses.

The total contributions for the beneficiary (who is under age 18 or is a special needs beneficiary) of this account in any year cannot be more than $2,000, no matter how many accounts have been established. The beneficiary will not owe tax on the distributions if, for a year, the distributions from an account are not more than a beneficiary’s qualified education expenses at an eligible education institution. This benefit applies to higher education expenses as well as to elementary and secondary education expenses.

Generally, any individual (including the beneficiary) can contribute to a Coverdell ESA if the individual's modified adjusted gross (MAGI) income is less than $110,000 ($220,000 if the individual is filing a joint return). The $2,000 maximum contribution per beneficiary is gradually reduced if the contributor's MAGI is between $95,000 and $110,000 ($190,000 and $220,000 if the contributor is filing a joint return).

Usually, MAGI for the purpose of determining your maximum contribution limit is the adjusted gross income (AGI) shown on your tax return increased by the following exclusion from your income: foreign earned income of U.S. citizens or residents living abroad, housing costs of U.S. citizens or residents living abroad, and income from sources within Puerto Rico or American Samoa. Contributions to a Coverdell ESA may be made until the due date of the contributor’s return, without extensions. 

Distributions are tax-free as long as they are used for qualified education expenses, such as tuition, books, fees, etc., at an eligible educational institution. This includes any public, private or religious school that provides elementary or secondary education as determined under state law. The Hope and lifetime learning credits can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses are not used for both benefits. Refer to Publication 970 for more details. If the distribution exceeds education expenses, a portion will be taxable to the beneficiary and will be subject to an additional 10 percent tax. Exceptions to the additional 10 percent tax include the death or disability of the beneficiary or if the beneficiary receives a qualified scholarship.

If there is a balance in the Coverdell ESA at the time the beneficiary reaches age 30, it must be distributed within 30 days. A portion representing earnings on the account will be taxable and subject to the additional 10 percent tax. The beneficiary may avoid these taxes by rolling over the full balance to another Coverdell ESA for another family member.

For more information, please see Publication 970, Tax Benefits for Higher Education. Download the publication or order it by calling toll free 1-800-TAX-FORM (1-800-829-3676).

Rollovers and Other Transfers

Assets can be rolled over or transferred from one QTP to another. In addition, the designated beneficiary can be changed without transferring accounts.

Rollovers

Any amount distributed from a QTP is not taxable if it is rolled over to another QTP for the benefit of the same beneficiary or for the benefit of a member of the beneficiary's family (including the beneficiary's spouse). An amount is rolled over if it is paid to another QTP within 60 days after the date of the distribution.

Members of the beneficiary's family.   For these purposes, the beneficiary's family includes the beneficiary's spouse and the following other relatives of the beneficiary.

1. Son or daughter or descendant of son or daughter.
2. Stepson or stepdaughter.
3. Brother, sister, stepbrother, or stepsister.
4. Father or mother or ancestor of either.
5. Stepfather or stepmother.
6. Son or daughter of a brother or sister.
7. Brother or sister of father or mother.
8. Son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law.
9. The spouse of any individual listed above.
10. First cousin.

 

Example.

When Aaron graduated from college last year he had $5,000 left in his QTP. He wanted to give this money to his younger brother, who was in junior high school. In order to avoid paying tax on the distribution of the amount remaining in his account, Aaron contributed the same amount to his brother's QTP within 60 days of the distribution.

Only one rollover per QTP is allowed during the 12-month period ending on the date of the payment or distribution.

Changing the Designated Beneficiary

There are no tax consequences if the designated beneficiary of an account is changed to a member of the beneficiary's family (defined above).

Example.

Assume the same situation as in the last example. Instead of closing his QTP and paying the distribution into his brother's QTP, Aaron could have instructed the trustee of his account to simply change the name of the beneficiary on his account to that of his brother.