As you or family members return to the classroom, remember that federal income tax breaks may help you pay for tuition and other costs of education. As a result of the American Recovery and Reinvestment Act of 2009 and cost-of-living adjustments, there are some new rules in effect for 2009 that can help you save for future education costs or pay for current obligations.
The Hope Credit, which had been a way to pay for the first two years of higher education, has been replaced with a new and improved tax credit for 2009 and 2010. The new credit, called the American Opportunity Credit, can be used to cover eligible costs for the first 4 years of higher education.
The credit amount is 100% of the first $2,000 of tuition and other eligible costs, plus 25% of the next $2,000 of such costs, for a total credit of $2,500 each year. (The Hope Credit had been limited to $1,800). The beauty of the revised credit is that 40% of the credit amount can be refundable; Uncle Sam sends you a check even though this is more than the taxes you owe.
The credit, however, phases out when your modified adjusted gross income (MAGI) exceeds a set limit. The following is the phase-out range in which you can claim a partial credit; fall below and you get the full credit, but exceed the limit and there’s no credit allowed:
If you are pursuing higher education beyond 4 years, there is still the Lifetime Learning Credit to help with education costs. This credit remains at 20% of the first $10,000 of eligible expenses, for a top credit of $2,000. However, the MAGI phase-out range for this credit is substantially lower than the one for the American opportunity credit. For 2009, the range is:
These plans (their name comes from the section of the Internal Revenue Code governing them) allow you either to prepay tuition or save for future education costs; both types of plans provide key tax incentives. While there is no federal tax deduction or credit for putting money into a plan (there may be state-level tax breaks), the contributions grow on a tax-deferred basis. Withdrawals to cover eligible expenses are tax free. For 2009, there are three important changes for 529 plans:
If you bought savings bonds after you were 24 years old and redeem them now to pay for higher education costs for yourself, your spouse, or your dependent, interest on Series EE or I bonds can be tax free. There is no ceiling on how much interest can be tax free; it depends on your MAGI. If you are below the phase-out range, then all interest is tax free; if you exceed the ceiling, no interest is tax free.
For 2009, the phase-out range in which some interest may be tax free has been increased over the 2008 limits; the range is:
Many people finance higher education by borrowing money. Interest on student loans is deductible up to $2,500 annually. The deduction is claimed as an adjustment to gross income, so you don’t have to itemize deduction in order to claim this tax break. However, the full deduction applies only if MAGI is below a set limit; a partial deduction applies for those with MAGI within a phase-out range. For 2009, the phase-out range has been increased over the 2008 limits; the range is:
There are many other tax breaks that can be used to help you pay for higher education. For example, the above-the-line deduction for tuition and fees continues to apply for 2009. It will not be available in 2010 unless Congress extends this break.
Payments within one tax year of the entire amount due to a participant in a qualified retirement plan. Qualifying lump sums may be directly rolled over tax free, or, in some cases, are eligible for current tax under a favorable averaging method.