Tax-advantaged strategies to fund children's college education continue to offer CPA clients some relief from that heavy financial burden, but their value will vary widely according to each taxpayer's financial picture.
The most significant recent change occurred last February when Congress enacted its $787 billion stimulus package, one component of which liberalized, for 2009 and 2010, the former HOPE education tax credit.
The new American Opportunity Tax Credit raised, from $1,500 to $2,500, the annual tax credit available per student, and allows the credit for all four years of a student's undergraduate education, instead of just the first two, according to Mark Luscombe, principal tax analyst for the Tax and Accounting Group of CCH in Riverwoods, Ill., and a tax columnist for Accounting Today.
Technically, the credit can be applied 100 percent to the first $2,000 in qualified expense, and 25 percent against the next $2,000. "They also raised the income limits for phasing out eligibility," Luscombe said, "to between $160,000 and $180,000 for joint filers and between $80,000 and $90,000 for single filers."
In addition, Luscombe noted that 40 percent of the credit is refundable, so that "even if you didn't owe any tax, there is the potential for getting some benefit."
Finally, the scope of eligible educational expenses covered by the American Opportunity Tax Credit was expanded to include "course materials," which, according to the Internal Revenue Service, means "books, supplies and equipment needed for a course of study."
The law is retroactive to Jan. 1, 2009, but would not apply to costs paid in 2008 for an academic semester beginning in 2009.
Income eligibility ceilings may render these tax credits of no use to high-income CPA clients, noted Neil Becourtney, CPA, a partner in the Roseland, N.J., office of J.H. Cohn: "We don't see a lot of our clients being able to take advantage of it."
What they do take advantage of, Becourtney said, is the workhorse of tax-advantaged college funding - the 529 plan. These arrangements, of course, are state-administered investment or savings vehicles whose investment income is exempt from federal (and typically state) tax when spent on college educational expenses.
"There is no income limit - Bill Gates could set one up," Becourtney explained.
If used for non-sanctioned purposes, investment earnings are both taxed and subject to an additional 10 percent penalty.
Although there are no explicit limits on annual contributions to 529 plans, federal law requires individual states to set limits such that total contributions don't ultimately over-fund a 529 account based on anticipated educational expenses.
Annual federal gift tax exclusion amounts ($13,000 in 2009 per donor; $26,000 for married couples filing jointly) may be a practical constraint for some clients, as the 529 account is established in the child's name. However, federal law allows taxpayers to front-load five years' worth of maximum gifts to a child via a 529 plan, according to Lisa Brinig, CFP, a wealth management consultant in San Diego with the cbiz Wealth Management Group.
CPAs need to be as mindful of states' tax treatment of 529s as they are of the federal government's, warned Saul Brenner, CPA, a New York-based partner with CPA and business advisory firm Berdon.
Currently, 34 states give their citizens tax incentives to participate in their 529 plan via a tax credit or deduction, with some allowing deductions for the entire 529 contribution.
Eighteen states offer prepaid college plans, which also fall under the general heading of a 529 plan. In effect, taxpayers pay for future course credits based on today's prices; the implicit "earnings" on the value of those credits as tuition costs rise are untaxed.
HORSES FOR COURSES
A variety of other tax-advantaged college financing plans are available. Clients whose parents have the means to help fund the college education of their grandchildren should be encouraged to exploit their annual gift tax exclusions by making gifts directly to the child. Or grandparents (or, for that matter, parents) can make tuition payments directly to the college without using up their gift tax exclusion, Brinig explained.
CCH's Luscombe reminded CPAs that Coverdell Education Savings Accounts, which operate on the same basic after-tax contribution principle as Roth IRAs, while only allowing $2,000 annual contributions, should not be overlooked. Coverdells are the only tax-advantaged savings vehicle that can also cover pre-college educational expenses, including elementary and secondary school.
A maximum of $2,500 of loans incurred for college are deductible annually, Luscombe explained. But relatively low income caps (total phase-out at $150,000 for joint filers) limit the value of that for many families.
Home equity loans may offer more flexibility. Interest on up to $100,000 in home equity used "for purposes other than the home itself" is deductible. "But you've got to watch the Alternative Minimum Tax," cautioned Brenner, since such interest is not deductible for AMT calculations.
Small-business owners, under certain situations, might be able to steer tax-advantaged dollars to a child who works for the family business through a Section 127 educational assistance program. "The business owner can pay up to $5,280 a year tax-free for higher education," Brinig said. However, such a program would have to be available to other employees, and thus may be impractical, she cautioned.
Brinig also explained that interest on Series EE Savings Bonds is not taxable if applied to education expenses - but they currently have extremely low yields.
Putting tax benefits in perspective, Brenner emphasized that the key to providing meaningful financial support for a child's college education is "to start saving money sooner than later; you can't just do it through your tax returns."
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