Notably, eligible expenses for the American opportunity credit include required course materials such as books and supplies
Tax benefits that help families bear the high and growing cost of higher education include deductions and credits, as well as tax-favored savings plans.
Children cannot claim the credit if they are a dependent on a parent’s tax return; however, any allowable expenses paid by the child can be treated as paid by the parents for purposes of calculating the credit (Sec
It is usually beneficial for the tax liability of the family as a whole for a child in college to be claimed by his or her parents as a dependent. Families should review the tests for qualifying children who are full-time college students.
If the student can be claimed as a dependent on another taxpayer’s return, he or she cannot take a deduction for student loan interest (Sec
Payments of student loan interest of up to $2,500 per year are deductible above the line, as are up to $4,000 in qualified tuition and fees. Both deductions are subject to modified adjusted gross income phaseouts.
In most cases, however, the American opportunity tax credit and/or the lifetime learning credit will yield a higher tax benefit for qualified educational expenses.
If families have a Sec. 529 or Coverdell education savings account , they should consider using distributions to cover college room and board, which are not eligible expenses for purposes of the credits or deduction.
) is an associate professor of accounting at the University of New Orleans. John W. Briggs () is an associate professor of accounting at James Madison University in Harrisonburg, Va.
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Income from scholarships is not included in the calculation of support of a taxpayer’s child (Sec. 152(f)(5)) (see Scholarships and Support, JofA, , page 56). The IRS has not given guidance on how distributions from Sec. 529 plans affect the support tests. These distributions can be substantial. If the distribution is counted as support provided by the beneficiary (child), it could prevent the child from qualifying as a dependent. Sec. 529 plans allow the owner (usually a parent or grandparent) to change the beneficiary. This provides some support for the argument that Sec. 529 plan distributions should count as support from the account owner and not count as support provided by the child, but tax practitioners are still waiting for a definitive answer from the IRS.
Forty percent of the American opportunity credit is refundable. 25A(g)(3)). The American opportunity credit is currently authorized only through 2012, when, without congressional action, the credit will revert to the pre-2009 Hope scholarship credit, which was available only for the first two years of college attendance, for a maximum annual nonrefundable credit (in 2008) of $1,800.
Example. Sally has $18,000 in a Sec. 529 savings plan. Her total annual educational expenses are $9,000: $4,000 per year for tuition and fees, and $5,000 per year for room and board. Sally could take a $9,000 distribution from her Sec. 529 plan in each of the first two years to pay all of her expenses. The distributions would not be taxable. However, she would not qualify for the education credits in those years. Instead, Sally could take a distribution from her Sec. 529 plan each year to pay only the $5,000 needed for room and board. By paying tuition and fees from nonSec. 529 funds, Sally (or her parents, if she is a dependent) could claim the American opportunity credit and receive a credit of $2,500 for each of the four years she is in college.
Most students have little or no tax liability while in school; therefore, it is usually beneficial for their parents or guardians to claim them as dependents. CPAs might start by reviewing with clients the tests that must be met for a qualifying child (Sec. 152). They are:
Married taxpayers filing separately cannot take the deduction. 221(c)). If the loan is in the student’s name, the parents may not take the deduction even if they pay the interest. Parents can deduct the interest only if the loan is in their name and they actually pay the interest.
Exhibit 1 shows a comparison for a family of four with two children in college. The parents have a combined salary of $100,000 and pay $4,000 of tuition and $1,000 for course-required books for each of their children, who are 20 and 21 years old and can be claimed as dependents on the parents’ joint tax return. The total qualified educational expenses for the American opportunity credit are $5,000 for each child. This results in a $2,500 credit for each child ($5,000 total credit).
Most states offer a deduction in calculating state income taxes for contributions to that state’s Sec. 529 plan. A few states offer a credit instead of a deduction (see tinyurl/ctum3fy).