There is an above-the-line deduction available for many individual taxpayers for qualified tuition and related expenses. The deductible expenses are defined in the same manner as they are for the purposes of the Hope Scholarship Credit and the Lifetime Learning Credit.

Basically, the deduction is allowed for tuition and related fees paid to a college or other institution of higher learning as a condition of enrollment or attendance of the taxpayer, the taxpayer's spouse or the taxpayer's dependent. Qualified tuition and related fees do not include expenses with respect to any course or other education involving sports, games, hobbies, or any non-credit course, unless the course or other education is part of the individual's degree program. Nor do they include the cost of books or room and board.

The deduction is generally allowed for qualified higher education expenses for any taxable year only to the extent that the expenses are in connection with enrollment at an institution of higher education during that taxable year.

However, the deduction also is allowed for expenses paid during a taxable year if those expenses are in connection with an academic term beginning during that taxable year or during the first three months of the next taxable year.

Under present law, the deduction is available only for higher education expenses paid in taxable years beginning before 2006.

The maximum amount deductible in taxable years beginning in 2004 and 2005 is $4,000. See below for a discussion of rules that prevent certain otherwise-eligible higher education expenses from being taken into account in determining the allowable deduction, and for modified adjusted gross income limits that may prevent any deduction from being taken.

Reduction in amount of allowable deduction for certain amounts excludable from gross income. The total amount of qualified higher education expenses taken into account in determining the higher education expense deduction has to be reduced by the following amounts that are excludable from gross income:

* Interest on U.S. savings bonds used to pay higher education expenses. Thus, an individual may not claim a higher education expense deduction for amounts taken into account in determining the amount of interest excludable from gross income with respect to U.S. savings bonds used to pay higher education expenses.

* Distributions of earnings (but not distributions deemed made out of contributions) from qualified tuition programs used to pay qualified higher education expenses. This means that an individual may not claim a higher education expense deduction for the amount of a distribution of earnings from a qualified tuition program that is excludable from gross income. However, a taxpayer may claim the deduction for the amount of a distribution from a qualified tuition program that is not attributable to earnings.

* Distributions from a Coverdell Education Savings Account, including distributions deemed made out of contributions. Thus, even if only a part of the distribution is made out of earnings, no part of the distribution may be taken into account in determining the amount of the higher education expense deduction that the distributee is entitled to claim.

Example 1: Your client's daughter receives a distribution of $5,000 from a Coverdell Education Savings Account. Of that amount, $2,000 represents earnings. She may not take any part of that distribution into account in determining the amount of any deduction that she is entitled to claim for higher education expenses.

Example 2: The same facts apply as in Example 1, except that the distribution was made from a qualified tuition plan. Your client's daughter may take the $3,000 of the distribution that was not made out of earnings into account in determining the amount of any deduction that she is entitled to claim for higher education expenses.

Observation: The amount of a distribution that is treated as made out of earnings is determined in the same way for qualified tuition programs and Coverdell Education Savings Accounts. Nevertheless, for qualified tuition programs, only the part of the distribution deemed made out of earnings is excluded for purposes of determining the deduction for higher qualified education expenses. On the other hand, for Coverdell Education Savings Accounts, the entire distribution is excluded.

MAGI limits on right to claim the deduction. In taxable years beginning in 2004 and 2005, no deduction is allowed a single taxpayer whose MAGI is more than $80,000, or to a couple filing a joint return whose MAGI is more than $160,000. A single taxpayer with MAGI over $65,000 but not over $80,000 and a couple filing a joint return with MAGI over $130,000 but not over $160,000 are limited to a $2,000 deduction instead of the $4,000 otherwise allowable in 2004 and 2005.

Observation: The otherwise allowable $4,000 deduction is not phased out in 2004 or 2005, but it is reduced to $2,000 if MAGI is more than the $65,000 ($130,000 for couples filing a joint return), and is lost entirely if MAGI is more than $80,000 ($160,000 for couples filing a joint return).

MAGI is AGI determined without regard to (a) the higher education expense deduction itself, (b) the exclusion under IRC § 911 of foreign earned income of U.S. citizens or residents, (c) the exclusion under IRC § 931 of income from Guam, American Samoa and the Northern Mariana Islands, (d) the exclusion under IRC § 933 of income from Puerto Rico, and, for taxable years beginning in 2005, (e) the deduction of 3 percent of the lesser of qualified production activities income or taxable income.

Individuals not entitled to deduction. The deduction is not available in any year to a married taxpayer who files a separate return, to an individual who is a nonresident alien for any part of the taxable year, or to an individual who can be claimed as a dependent on another taxpayer's return.

Observation: Thus, a student who can be claimed as a dependent on his parent's tax return cannot take the deduction for higher education expenses, even if he pays the expenses out of his own funds.

Other limitations on deduction of higher education expenses. The deduction isn't allowed for any expense for which a deduction is allowed to the taxpayer under any other provision of Chapter 1 of the Internal Revenue Code (dealing with normal taxes and surtaxes).

Also, the deduction isn't allowed for a year if the taxpayer or any other person elects to claim a Hope Credit or Lifetime Learning Credit with respect to that individual for that year. Thus, a taxpayer isn't eligible to claim the higher education expense deduction and a Hope or Lifetime Learning Credit in the same year with respect to the same student. In my next article, I will discuss factors to consider in determining whether to claim the deduction or one of the education credits.

Observation: This limitation applies even if the total amount of higher education expenses would otherwise have been enough to allow both an education credit and a higher education expense deduction.

Example 3: Your client paid college tuition in the total amount of $10,000 for her son for the first semester of his freshman year, which he started in September of 2004. Your client is already using the Lifetime Learning Credit with respect to tuition paid for her daughter's junior year in college. For her son, your client will be eligible to claim either the Hope Scholarship Credit in the maximum allowable amount of $1,500 by using $2,000 of the tuition expenses, or a higher education expense deduction of $4,000. (The maximum credit equals the sum of 100 percent of the first $1,000 of allowable expenses, and 50 percent of the next $1,000.)

Thus, even though the total tuition your client will pay for 2004 is $8,000 more than the amount needed to claim the maximum Hope Scholarship Credit, if she claims that credit she will not able to deduct any part of the rest of the tuition as a higher education expense.

Bob Rywick is an executive editor at RIA, in New York, and an estate planning attorney.

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