Education Tax Breaks

        Tax breaks for educational expenses provides more than a quarter of the $151.6 billion tax-cut that formed part of the historic Taxpayer Relief Act of 1997. These new tax breaks continue for 2002 and 2003.

        All of these tax breaks for education focus directly on the individual student or the family of the student, rather than on the educational institutions themselves. These education provisions, most of which have been effective since the beginning of 1998, can mean thousands of dollars in tax savings not only for taxpayers with children in college or graduate school, but also for those who pursue further education and training to help them at work.

        Unfortunately, many of the new education tax breaks are complicated. Maximizing the benefits from these new deductions, credits, exclusions and opportunities for tax-free savings often require careful planning, particularly because of the interrelationship between many of the rules. Although the Internal Revenue Service has provided additional guidance to help taxpayers comply with all the rules, some of these new IRS procedures have actually complicated matters in some circumstances.

        The primary new tax breaks carved out for education include the following:

        Education tax credits. These consist of two separate credits the "HOPE" scholarship credit of up to $1,500 per year per student for tuition and fees for each of the first two years of college, and the Lifetime Learning credit that is worth up to $1,000 ($2,000 beginning in 2003) per year for an unlimited number of years for college juniors, seniors, graduate students or working Americans pursuing job skill training. Employees will benefit from the new Lifetime Learning credit since it includes tuition and related expenses in connection with any course of instruction at an eligible educational institution to acquire or improve job skills. The benefits of the credits begin to get "phased out" for couples with more than $80,000 in adjusted gross income ($40,000 for singles). The credits apply to qualified tuition and related expenses of the taxpayer, the taxpayer's spouse, or any dependent of the taxpayer for whom a personal exemption can be claimed. Some tricky rules on course-load levels and covered expenses apply.

        Extension of employer-provided educational assistance exclusion. The '97 Tax Act extended the employee exclusion of up to $5,250 of employer-provided education assistance to courses beginning before January 1, 2002. While not applying to graduate-level courses, excludable education allowances from an employer need not be related to the employee's current job.

        Education IRA. A new education IRA allows taxpayers to open up an IRA specifically for a child's education and make annual contributions of up to $500 per child. Although these contributions won't be deductible from your return against other income, the earnings build-up will be tax-free and withdrawals to pay for qualified higher education expenses will also be tax-free. Fortunately, income phase-outs are quite high, beginning at $150,000 for couples and at $95,000 for single filers.

        Deduction for interest on education loans. Student loan interest of up to $2,500 will be deductible whether or not a taxpayer itemizes deductions. This limit will remain in effect until 2006.  The deduction is available with certain income phase-out limits each year.

        Other beneficial education incentives in the new tax rules include penalty-free withdrawals from retirement IRAs for higher education expenses and expanded tax-free treatment for state prepaid tuition plans. Undoubtedly, some of these provisions will be more important to you than others, depending upon personal circumstances. If you would like to explore how the new legislation can work for you and have us fully evaluate your situation, please do not hesitate to call.

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