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Plan Well, Retire Well

Saving and investing your money

Tax News for College Expenses and Student Loans


Many of you are familiar with Karen Chan from her posts to this blog. Karen retired in July but we're happy to bring her expertise back with this post about the American Taxpayer Relief Act of 2012 -- and what it means for those with college expenses and/or student loans! Glad to have you back, Karen.

Tax Break

Maximum Amount

Type of tax break

Maximum Tax Savings*

Student Loan Interest Deduction

$2500

Tax deduction

$750

Employer Provided Education Assistance

$5250

Non-taxable income

$1575

American Opportunity Tax Credit

$2500

Tax credit

$2500

Tuition and Fees Deduction

$4000

Tax deduction

$1200

Coverdell Education Savings Account

$2000 annual contribution

No tax on growth

$600, assuming 12 years of growth at 6% per year

*For 25% federal and 5% state income tax brackets.

The Fiscal Cliff was in the headlines for months. Everyone was aware that individual tax rates, various tax breaks, and estate taxes would be affected by what Congress did. Now it's time to see how the finer points may affect you. If you have a child in college, are paying back student loans, or are saving for college, the American Taxpayer Relief Act of 2012 (ATRA) contains some good news for you. And while I may use the word "college," these benefits are also generally available to anyone pursuing a recognized, post-secondary credential.

I've been writing about tax breaks for higher education for years, and one of my frustrations has been the uncertainty from year to year as to what rules would expire and which ones Congress would extend at the last minute. ATRA made some things permanent, and temporarily extended others yet again. Let's take a look.

If your kids are young and you're only interested in saving for college right now, skip to the last heading – Coverdell Education Savings Accounts.

Student Loan Interest Deduction

Student loan debt lives on for years after your graduation. You can deduct up to $2500 of interest on student loans each year. The original law said you could only deduct the interest on your first 60 loan payments. Later, the 60-payment limit was removed – temporarily. ATRA has now removed the 60-payment limit permanently. You can deduct up to $2500 of interest each year, no matter how long you have been paying on your loan. The amount of your deduction will be gradually reduced to $0 if your income is $60,000 to $75,000 for single filers and $125,000 to $155,000 for married persons filing jointly.

This tax break is very valuable to college grads who are just getting started in life because it's an above the line deduction. You don't have to itemize deductions to claim this one. No mortgage, no property taxes, or large charitable donations to itemize? No problem. You subtract this deduction from your income right on the front of your 1040 or even on your 1040A, just not on the 1040EZ. A deduction of $2500 could save you $750 in taxes, if you're in the 25% federal tax bracket and 5% state.

Employer Provided Education Assistance

If you're lucky enough to have an employer who reimburses you for college expenses, that's a great benefit. What's even better is getting that help tax-free. The rule is now permanent: your employer can pay up to $5250 toward your education expenses and it does not count as income. If you're in the 25% federal tax bracket and 5% state, that'll save you up to $1575.

American Opportunity Tax Credit

First, we had the Hope credit that was good for the first two years of college. After that, you had to switch to the good-but-less-valuable Lifetime Learning Credit. Then President Obama introduced the American Opportunity Tax Credit which expanded the Hope credit into a four-year deal, worth up to $2500 each year. ATRA extends the American Opportunity Tax Credit through 2017. If you have kids who are freshmen now or starting in the fall, you'll have this valuable credit each year through their senior year.

You get a credit equal to your first $2000 of expenses. For the next $2000 of expenses, your credit is 25%, for a grand total of $2500. Since it's a credit rather than a deduction, it reduces your taxes dollar for dollar. There are income limits. You deduction will be gradually reduced to $0 if your income is between $80,000 and $90,000 (single) or between $160,000 and $180,000 (joint).

Tuition and Fees Deduction

The Tuition and Fees Deduction has once again been extended, but just a little, to the end of 2013. This has been the story of the deduction's life. Since this deduction first appeared in 2002, it has been scheduled to expire every couple of years. Now, ATRA has reinstated it retroactively for 2012 and through 2013. You may not even need it, because you can't claim both it and the American Opportunity Credit for the same student. And you can't claim both it and the Lifetime Learning Credit for the same student. You'll want to try doing your taxes both ways to see which tax break saves you the most.

This is also an above-the-line deduction, so you can claim it even if you don't itemize. You can deduct up to $4000 in tuition and fees, but your limit is $2000 if your income is in the phase-out ranges: $65,000 to $80,000 (single) and $130,000 to $160,000 (joint). A $4000 deduction could save you $1200 in taxes.

Coverdell Education Savings Account

Parents saving for college have three main choices: 529 prepaid tuition plans, 529 savings plans, and Coverdell Education Savings Accounts, formerly known as Education IRAs. The tax breaks associated with these three programs are the same: you don't owe any income tax on the increase in value in the account as long as you use the money for qualified education expenses. But the Coverdell is unique in that it can also be used for K-12 expenses. You even have until April 15 to make a contribution to a Coverdell for 2012, just like an IRA. The amount you can contribute is phased out for incomes between $95,000 and $110,000 for singles, $190,000 and $220,000 for married couples filing jointly.

At the beginning Coverdell Education Savings Accounts were largely ignored because of the tiny contribution limit: you and all your other relatives combined could contribute just $500 per year for your little Susie's education. It was hardly worth the effort. Then the limit was increased to $2000 – but only through 2012. Finally, the $2000 annual limit has been made permanent. My hope is that this will encourage low-cost mutual funds to begin (or resume) offering Coverdell Accounts. With small accounts like this, it's especially important to choose providers with minimal fees. Right now, brokerages seem to be the main option.

For more details about these and other tax breaks for higher education, check IRS Publication 970, Tax Benefits for Education.



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