Scott Karl College Planning Fresno Serving Clients Throughout California

The Economic Growth and Tax Relief Reconciliation Act was passed all the way back in June 2001.

And like many tax bills, this act makes a horribly complicated situation even more complex!

The last reform in 1997 filled the tax laws with loopholes, pitfalls, and financial minefields. This reform adds a few more — and throws in time limits for good measure.

First, though, the good news. There are a number of new benefits available for families paying college tuition fees:

Withdrawals from qualified state tuition programs (like Section 529 plans) are now tax-free. You also have more control over these plans. Instead of having to both transfer funds to a different plan and change the beneficiary if you want to avoid tax penalties, you can now simply switch plans penalty-free once a year.

Coverdell ESA’s (the old Education IRA’s) are bigger. Instead of being capped at $500, beneficiaries under the age of 18 can now receive up to $2,000 per year. There’s no tax deduction for the contribution, but the tax is deferred on the fund’s growth, and withdrawals are tax-free for qualified expenses. (These expenses have been expanded to include computers and internet access.) There’s also a useful loophole in this law: while there are income limits for high-earning contributors, anyone can contribute, including lower-earning relatives.

The “Hope Credit” remains untouched. The Hope Scholarship Credit cannot exceed $2,500. The amount parents can claim is equal to 100% of qualified tuition and related expenses not in excess of $2,000 plus 25% of those expenses in excess of $2,000 but not to exceed $4,000.

The “Lifetime Learning Credit” has been increased. The Lifetime Learning Credit provides a tax credit of up to $2,000 for educational expenses. The amount of the credit is equal to 20% of the first $10,000 of qualified tuition related expenses. (It’s important to note that both these credits are calculated according to “out-of-pocket” expenses. Scholarships and grants may reduce the credit; loans may not.) It’s also important to note that these two credits will be phased out for single filers with incomes less than $54,000, and joint filers with incomes less than $108,000 and you can only use one credit per student.

There is a new deduction of up to $4,000 for educational expenses. You can take this deduction even if you don’t itemize your deductions, or you have an Adjusted Gross Income (AGI) of less than $65,000 for a single parent or $130,000 for a couple filing jointly. On the downside, if you do take this deduction, you can’t take the Hope or Lifetime Learning Credit for the same student in the same year. (You’re probably better off taking the education credits if you can, but you should definitely get the advice of a professional college funding advisor to see which is best for you.)

Deductions for the interest paid on qualified student loans have been expanded. The interest deductions have been raised to $2,500, and the deduction will no longer be limited to the first 60 months of interest payments.

That’s the good news.

There’s also a fair amount of not-so-good news:

First, all these benefits come with a sale-by date. Some provisions in the law only last a few years (the new $4,000 deduction, for example, ended in 2006.) That’s definitely something to consider if you’ve got more than one child heading to college over the next few years.

Some middle-income families may be cut out of many of the new benefits. If you earn more than $50,000 (or $100,000 for joint filers), for example, you won’t get the full $2,500 of student loan interest deductions. If your income is over $65,000 (or $135,000 for joint filers), you won’t get any of these deductions.

Timing is crucial. Because your eligibility for some of these deductions will depend on the tax year you make the payments; you’ll have to plan all your college payments very carefully. Pay a tuition fee too early, and you could find yourself unable to claim a tax credit!

You can’t win them all! Applying for one credit may make you ineligible for another. The same child, for example, cannot earn you both a Hope Credit and a Lifetime Learning Credit in the same year. Nor can you claim either of these credits for expenses paid with money pulled out of 529 Plans or Coverdell ESA’s.

Most importantly, many of these benefits will have an effect on your EFC. Picking up a Hope Credit or Lifetime Learning Credit, for example, will leave you with more untaxed income. That means colleges may lower their financial aid packages. You should still end up paying less money, but you’ll need to figure out precisely how much.


Pretty confusing stuff, huh?

The truth is If Your CPA Or Tax Preparer Doesn’t Understand How The Financial Aid System Works…

His/Her use of these tax rules to save you $1,500 in taxes (The maximum allowed by law) could cost you many more thousands of dollars in lost financial aid!

Where does that leave you as a parent of a college-bound student?

Up the creek, if you don’t understand how each of these provisions applies to you, and which credit is best to take and when.

One of the results of the new tax law is that individualized advice has become more important than ever.

One solution will not fit all!

The way parents of college children arrange their finances to pay tuition fees will now vary more widely than ever from one family to another.
The only way to make sure you’re not paying more than you need for your child’s education is to sit down with a qualified college funding expert and find the best financial arrangement for you!

Check your email next week for the next “College Tip” in my series where I will be discussing how to get maximum money for college if you’re divorced, minority, own a business, recently unemployed or the parent of an athlete.