A.  IRA owners under age 59 1/2 can withdraw funds from their accounts penalty free if the funds are used to pay eligible education expenses for the taxpayer, the taxpayer's spouse, child or grandchild of the taxpayer or the taxpayer's spouse.

(1) Taxpayer must include the distribution in income and pay income tax on it; only 10% early distribution penalty that would otherwise apply is avoided.

(2) Grandparents, who are eligible to tap their IRAs to help their grandchildren pay for college may want to pay the funds directly to the educational institution to avoid the $10,000 annual gift tax exclusion limit.

(a) Gifts directly to an educational institution are without any limit and can be made in addition to the $10,000 annual gift tax.

B.   Waiver of the penalty applies only to distributions taken on or after January 1, 1998 for qualified higher education expenses in academic periods beginning on or after that date (Notice 97-53, IRB 1997-40,6).

(1) Example: If an IRA owner's child is enrolled for the academic year starting September 1997 through May 1998, only withdrawals taken for expenses paid after December 31, 1997 qualify for the exception to the penalty. Thus, if withdrawals are taken in January to pay for the second semester starting on February 1, the exception to the penalty would apply.

(2) Academic period includes a quarter, trimester, semester or any other period designated by the educational institution.

(3) Qualified higher education expenses include not only tuition and fees but also books, supplies and equipment required for enrollment.  It also includes room and board if the student is enrolled at least halftime.

Note: Waiver of 10% penalty allow applies to ROTH IRA distributions that meet the above requirements.

Interest on student loans

A.  General rules

(1) Beginning on January 1, 1998, interest may be partially deductible

(2) Top deduction in 2000 is interest of $2,000

(a) It increases to $2,500 in 2001.

(3) Deduction can be claimed by the taxpayer for loans taken to allow them, their spouse or dependents to attend an eligible educational institution

(4) Deduction applies only for interest made during the first 60 months in which interest payments are required on the loan

(a) Student must be enrolled at least halftime

(5) Loan need not be a guaranteed or subsidized student loan; as long as it is used for eligible costs, the deduction can be taken

(6) For purposes of deducting student loan interest, eligible costs have the most liberal definition for any tax incentive

(a) They include tuition and fees, books, equipment, room and board, and any other necessary expenses (e.g., transportation)

B.  Limit on deduction

(1) Deduction is limited to those with MAGI of $40,000 or less, or $60,000 on a joint return

(a) Deduction phases out for those with MAGI between $40,000 and $55,000 ($60,000 and $75,000 on a joint return)

(b) Example: In 2000, if a single parent with MAGI of $47,500 pays interest on a student loan, only $500 is deductible

(c) MAGI limits will be indexed for inflation after 2002

C.  Other rules

(1) Former students with loans outstanding may be eligible for the deductible, depending on whether payments are made within the first 60 months that interest is required on the loan

(a) If interest payments were required before January 1, 1998, they count against the 60-month time limit for the loan

(b) Of course, the 60-month period may run out at different times for different loans

(2) Deduction is taken as an adjustment to gross income

(3) If the student takes the loan and is a dependent of his or her parents, the student is not eligible to claim the deduction

(a) Once the student is no longer a dependent, any interest payments may be deductible assuming the 60-month limit is met

D. Other education incentives

1. Employer-provided education assistance

a) $5,250 exclusion applies to courses begun before June 1, 2000

b) Exclusion applies without regard to individuals AGI

c) Employer treats education assistance as a tax-free benefit on the employee's W-2 form

d) Exclusion applies only to tuition and related expenses for undergraduate courses

(1) Graduate courses are not eligible for the exclusion

(2) However, undergraduate courses need not be job related

e) Job-related graduate level courses paid by the employer may qualify as a tax-free working condition fringe benefit if the courses must maintain or improve skills required for the current job or satisfied certain express employer-imposed conditions for continued employment

f) Note: If the student's employer pays for undergraduate courses, the student cannot claim a HOPE credit or lifetime learning credit

2. Deduction for education costs

a) Taxpayer can deduct the education costs undertaken to maintain or improve skills required on his or her present job, or to meet the requirements of the present employer of applicable law or regulations as a condition to the retention of present employment or salary (Code Sec. 162)

b) Deductible expenses include tuition, books and supplies and the cost of travel, board and lodging if the education is away from home

(1) Person need not enroll on any particular basis

(2) Deduction applies to any educational course, including seminars, correspondence study courses, and continuing education courses

(3) Deduction does not apply to education leading to a new trade or business

(a) Example: CPAs who attend law school cannot deduct their costs even though they plan and do continue to act as CPAs following law school. The reason: Attendance at law school qualifies them for a new trade or business, namely, that of being a lawyer.

c) Deduction for education costs is an unreimbursed itemized deduction subject to the 2% AGI floor

(1) Some of even all of the deduction may be lost because of the 2% limit

(2) Self-employed individuals can take their educational expenses as a deduction on Schedule C and the deduction is not subject to the 2% limit.

 

Estate Planning 

Tax Incentives for Saving for Higher Education

Qualified State Tution Programs

Education IRA's

Tax Incentives for Paying for Higher Education Expenses

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