Many back-to-school college students and their families are facing the toughest time in years, in meeting the costs of higher education due to the recent economic downturn. In an attempt to face this challenge, Congress recently passed some tax relief for college students and families that, together with scholarships, loans and work-study grants, can provide invaluable lifelines this year. The tax relief is twofold: the new American Opportunity Tax Credit and more liberal withdrawal rules for Section 529 plans to cover technology needs. Both tax provisions are temporary – for 2009 and 2010 only – but likely will be extended in some form if the need continues.
American Opportunity Tax Credit
For 2009 and 2010, Congress has enhanced the Hope Scholarship Credit and has renamed it the American Opportunity Tax Credit. The 2009 Recovery Act makes the credit available to more families than the Hope Credit. Not only can the American Opportunity Tax Credit be used for the first two years of post-secondary education, but it is available for the third and fourth years of college as well. Further, the credit can be taken for more expenses, such as text books and course materials. And, although the credit phases out as adjusted gross income rises, the income phase out range has been increased. Additionally, 40 percent of the credit is refundable.
ABCs of the AOTC: The American Opportunity Tax Credit (AOTC) is available for 2009 and 2010 up to a maximum of $2,500 per eligible student per year (100 percent of the first $2,000 eligible expenses plus 25 percent of the next $2,000 eligible expenses). The credit phases-out at higher income levels, making the credit available to more families as well. For single taxpayers, the phase out range is increased to $80,000 – $90,000 AGI, and for married joint filers the credit phases out when AGI falls between $160,000 – $180,000.
You cannot claim the above-the-line higher education expense deduction (of up to $4,000) in the same year that you claim the AOTC or Lifetime Learning Credit; you must choose among these tax benefits. If you have a choice between the AOTC and the Lifetime Learning Credit, or the higher education expense deduction, you may find that the AOTC garners you more tax savings. Although the credit will usually result in more tax savings, you should calculate the effect of the AOTC, Lifetime Learning Credit and higher education expense deduction on the tax return to see which achieves the greatest tax savings. Remember, also, in “doing the math” that the tax benefits are based on calendar tax years and not school academic years.
Technology expenses and Section 529 Plans
New for 2009 (and 2010) parents and students can take tax-free withdrawals from their prepaid tuition plans (“529 plans”) to buy computers and computer-related equipment for college. The American Recovery and Reinvestment Act of 2009 (2009 Recovery Act) added computers, computer equipment, technology, internet access and “related services” to the list of qualified higher education expenses that can be paid for with tax-free 529 withdrawals. However, as with the AOTC, this expansion is temporary and applies only for 2009 and 2010 … unless Congress extends this new tax break.
Section 529 plan coverage. Qualified tuition programs, more commonly referred to as 529 plans, allow you to either prepay or contribute to an account set up for paying a student’s qualified education expenses at eligible educational institutions. When withdrawals are taken to pay for qualifying education expenses they are tax-free. Qualifying expenses include tuition, fees, books, supplies and equipment required for enrollment or attendance of the student at an eligible educational institution (and expenses related to special needs services for special needs students). They also include expenses for room and board as long as the student is enrolled in a degree or certificate program at least part time. Now, thanks to the 2009 Recovery Act, they also include expenses for computers and computer-related equipment and services.
The types of computer and related technology and equipment that can be purchased with tax-fee withdrawals are fairly expansive. Expenses include those made to buy: computers, computer software, peripheral equipment, fiber optic cables related to computer use, as well as internet access and related services. The computer and/or computer-related must be used by the student or family members during enrollment in college (or other post-secondary institution).
Exceptions. Tax-free withdrawals can not be taken for computer software designed for games, sports or hobbies, unless the software is “predominantly educational in nature.”
Additionally, while the tax law allows you to combine the tax benefits of a 529 plan with one of the education credits or deductions, you cannot “double dip.” That is, the expenses you use to compute the AOTC (or Lifetime Learning Credit) cannot also be included as a qualified higher education expense for purposes of determining your tax exclusion for 529 plan withdrawals.
Remember also that states have their own rules regarding education benefits, such as 529 plans and withdrawals. These must be considered as part of your education tax savings strategy.
Please contact us to discuss the higher education tax saving strategies that can best benefit your particular situation.