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Tax Benefits
Education Tax Incentives*
Chela's Private Loans, Non School-Certified Loan and School-Certified Loan, and Federal Loans all offer money-saving tax benefits that may potentially benefit you and your family. The Taxpayer Relief Act of 1997 provided these education-related tax incentives, which come in several varieties, including education-related credits, interest-rate deductions, tax exclusions, and tax deferment.
Please keep in mind that these tax incentives may have tax and other consequences. Consult your tax advisor for more information to determine if they are appropriate for your situation.
Also take a look at the other tax incentives described below:
Tax Credits
The most popular education tax benefits offered by the federal government are the Hope Scholarship and Lifetime Learning credits. These family credits allow eligible taxpayers to claim a tax credit against their federal income tax for qualified tuition and other related expenses. They are an ideal supplement to Chela's family of products: the Non School-Certified Loan, School-Certified Loan, and federal loan programs.
Taxpayers can't claim both the Hope Scholarship credit and the Lifetime Learning credit for the same student in the same tax year.
Hope Scholarship Credit
This credit is available for the first two years of post-secondary school when the student is enrolled at least half-time in a degree or certificate program. Advantages include:
- The Hope Scholarship credit is calculated on a per-student basis, not per-family, so it can be claimed by more than one family member.
- You can claim up to $1,500 per student against your income tax: 100% of the first $1,000 out-of-pocket education expenses and 50% of the next $1,000. This credit is subject to certain income limits and other restrictions.
- Out-of-pocket expenses include tuition and those costs not covered by other assistance you've received.
- You can't cover room and board, books, certain activity fees, and insurance. Any tuition and expenses covered by a federal Pell Grant or other tax-free scholarship, a Coverdell ESA, or employer-provided assistance are also not covered.
- You can opt to let your child have a tax-free Coverdell ESA, or he or she can waive the tax-free treatment so you can claim the ESA as a credit. If you choose to take the credit for your income tax, either you or your child can use it, but not both of you.
Lifetime Learning Credit
A major benefit of the Lifetime Learning credit is that it is available to students who may be taking as little as one course, as opposed to the Hope Scholarship credit, where students need to be enrolled at least half-time in a degree or certificate program. It's available for undergraduate and graduate students, as well as students who are taking continuing education courses or courses to acquire or improve job skills.
- Unlike the Hope Scholarship credit, the Lifetime Learning credit is calculated on a per-family basis, rather than a per-student.
- You're allowed to claim a credit equal to 20% of the first $5,000 for out-of-pocket expenses for qualified tuition and costs for all of the students in your family.
- You can combine more than one family member's expenses, but the credit is capped at a per-family limit based on family income. After 2002, the maximum credit you can claim is $1,000 per family per year.**
Income Tax Deduction
You can deduct up to $3,000 of qualified tuition and related expenses - including student loan payment interest - if your adjusted gross income (AGI) is $65,000 or less, $130,000 or less for a joint return. In 2004 and 2005, the deduction jumps to $4,000 with the same AGI limits. The expenses can be for you, your spouse, or your child. You can't take a deduction in the same year that you take a Hope Scholarship or Lifetime Learning credit. Contact your tax advisor for more information.
529 College Savings Plans
A 529 college savings plan is a state-sponsored program that allows parents, relatives, and friends to invest for an individual's college education. Named for the IRS code that created it, the 529 college savings plan is part of the Small Business Job Protection Act of 1996. Known also as a QSTP (Qualified State Tuition Program), a 529 college savings plan is similar to an IRA (Individual Retirement Account). However, as many different states set them up, they may vary from state-to-state.*
Benefits include:
- Taxes on investment earnings from 529 college savings plans are deferred, meaning that they accumulate earnings more rapidly.
Funds from a 529 college savings plan won't be taxed at withdrawal as long as it's used for qualified education expenses.***
- If funds are withdrawn from a 529 college savings plan for reasons other than to pay for higher education, the funds are subject to a tax penalty. However, if the student-beneficiary wins a higher education scholarship, funds equal to the scholarship amount may be withdrawn from the 529 college savings account without a penalty.
- Account holders have permanent control over the account and can switch the account beneficiary to another family member if ever needed.
- There is no limit to the amount that you, other family members, and friends can contribute each year, as long as it doesn't exceed the lifetime maximum - which can be as much as $305,000, depending on the state.
- If you choose to open a 529 college savings plan, you're still able to claim a Hope Scholarship Credit or Lifetime Learning Credit, but the money from the 529 college savings plan can't be used for the same expenses covered by these credits.
Prepaid Tuition Plans
A prepaid tuition plan is a program that allows parents, relatives, and friends to prepay an individual's future college education costs at today's tuition prices at eligible institutions. There are two types of Prepaid Tuition Plans:
- State Plans, which enable students to attend an in-state public college when they reach college-age.
- Private Plan (also called the Independent 529 Plan), which enables students to attend one of over 200 participating private colleges.
However, as many different states and colleges set them up, they may vary from state-to-state.*
Benefits include:
- Taxes on investment earnings from prepaid tuition plans are deferred, meaning that they accumulate earnings more rapidly. Funds from a prepaid tuition plan won't be taxed at withdrawal as long as it's used for qualified education expenses.***
- If funds are withdrawn from a prepaid tuition plan for reasons other than to pay for higher education, the funds are subject to a tax penalty. However, if the student-beneficiary wins a higher education scholarship, funds equal to the scholarship amount may be withdrawn from the prepaid tuition account without a penalty.
- Account holders have permanent control over the account and can switch the account beneficiary to another family member if ever needed.
- Most prepaid tuition plans set contribution limits prior to purchase based on the age of the beneficiary and number of tuition credits purchased.
Coverdell ESA (formerly Education IRA)
Anyone - friends, family, or the student her- or himself- can contribute to a Coverdell Education Savings Account (ESA), formerly called an education IRA. Much like a self-directed IRA, an ESA gives you total discretion on how to invest.
As with 529 plans, money in an ESA grows tax-deferred, and withdrawals are tax-free when used for qualified education expenses, which can include everything from tuition to school uniforms and Internet service. You can contribute up to $2,000 per year to an ESA per beneficiary as long as your adjusted gross income (AGI) is less than $95,000 for single filers (phased out at $110,000) or $190,000 for joint filers (phased out at $220,000).
The beneficiary has until age 30 to use the money. And if the child doesn't need all the ESA funds for education, he or she can roll over the account - tax-free - to another family member.
Tax Exclusion
Employers may provide up to $5,250 per year in educational assistance to employees on a tax-free basis for either undergraduate or graduate education. Courses that began before June 1, 2000 currently qualify, pending extension of the program by Congress. This benefit is valid whether or not the education is job-related. You can attend school full-time, half-time, or even take just a course or two.
IRA Withdrawals Without Penalties
If you have regular, non-education traditional or Roth IRAs, you may withdraw funds from them penalty-free to pay for education-related expenses not covered by Hope Scholarship or Lifetime Learning credits. These expenses include books, supplies, and equipment, as well as tuition and fees. If the student is enrolled at least half-time, room and board can also be included. IRA funds can be used to pay for qualified expenses for any family member the taxpayer chooses: children, grandchildren, a spouse - even for her- or himself. While there's no penalty, federal income tax is on the amounts withdrawn.
Education Savings Bond
Students and family-members who own Series EE and Series I bonds should note that you may exclude interest on these types of bonds from your gross income if you're paying for college expenses in that same year. Each bond must be in the owner's (the taxpayer's) name, and the owner must be at least 24 years old. The student using the bond must be enrolled in at least one post-secondary course.
* The information provided is to be used as a guide only. Visit the IRS website for the most up to date information.
** This credit is subject to certain income limits and other restrictions.
*** This applies for distributions made in 2002-2010. Unless Congress extends this provision, distributions of earnings made in 2011 will be taxable to the beneficiary.
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