EDUCATION TAX INCENTIVES

Congress passed a flurry of tax incentives as part of the Taxpayer Relief Act of 1997 and further enhanced these incentives with EGTRRA of 2001.  The incentives certainly will help some families, but they are complicated and impose widely different restrictions.


OVERVIEW OF THE MAJOR INCENTIVES

• Hope Scholarship Credit
  Families can claim an annual credit on their federal tax return (this is money subtracted directly from any tax they owe) of up to $1,650 (in 2007) for the first two years of college for each student.  This applies for eligible expenses such as tuition and fees incurred.

• Lifetime Learning Credit
  This annual credit is for up to $2,000 (20% of $10,000 for 2007) for eligible college expenses incurred.  It may not be taken for the same student who receives the Hope Scholarship Credit in that year but it is available for an unlimited number of taxable years.

• Coverdell Education Savings Account – Formerly Education IRA
  The Economic Growth and Tax Relief Reconciliation Act of 2001 replaced the Education IRA with the Coverdell Education Savings Account.  Individuals may contribute a non-deductible maximum of $2,000 to this account for a child under 18.  The earnings are not taxed as long as the funds are used to pay qualified education expenses.  Funds must be withdrawn by the time the child reaches age 30.  Unused funds may be transferred to another family member’s Education Savings Account.
  
  Unlike the Education IRA, the Education Savings Account can be used for elementary and post secondary qualified education expenses.

• Deductible Student Loan Interest
  Interest on student loans is deductible up to the maximum of $2,500.  This deduction was previously limited to 60 months but that restriction was permanently repealed by the Pension Protection Act (PPA) of 2006. 

• Pre-Paid Tuition Plans Expanded
  Money put into pre-paid state tuition plans can now be used for room and board as well as tuition and fees.

• IRA Withdrawals
  Taxpayers can now withdraw funds before age 59½ from their traditional or Roth IRAs to pay for college expenses without paying the 10% early withdrawal penalty (you still have to pay income taxes on the withdrawal from the traditional IRA).

The ability to contribute to the Coverdell Education Savings Account phases out for joint-filing taxpayers with modified AGIs of $190,000-$220,000 in 2007 (for single taxpayers, $95,000-$110,000). 

The deduction for student loan interest is gradually phased out for joint filing taxpayers with MAGI over $110,000 and single filers over $55,000 (in 2007).  No deduction is available for those with incomes above $140,000 and $70,000 respectively.

For some taxpayers, interest earned from EE bonds can be used tax free for college expenses.  However, you cannot claim the EE bond interest exclusion and the Hope or Lifetime Credits in the same year for the same student.  You may also contribute to a pre-paid state tuition plan and a Coverdell Education Savings Account, in the same year, for the same child. 

In addition, be aware that use of these incentives may in turn reduce financial aid.  Withdrawals increase your income, which a college takes into account when calculating financial aid.

Sources:  Tax Facts 2007, National Underwriter Company
                  www.irs.gov pub 970 Tax Benefits for Education