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Tax Benefits Change for College Funding Programs

Tax and Financial News

October, 2010

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Tax Benefits Change for College Funding Programs

Everyone knows the cost of college tuition has skyrocketed to almost incomprehensible levels. According to CollegeBoard.com, the average tuition and fees for in-state students at a public four-year college is $7,020, while the average full-time, out-of-state price tag is $11,528.

Compare that to private four-year colleges that charge an average of $26,273 per year in tuition and fees, and the numbers can make any student – and most parents – extremely nervous.

Thank goodness for education tax credits that provide tax relief. However, students and parents alike must pay attention to some very important changes in several of the key plans.

What Stays the Same?

The American Opportunity Credit does not change for 2010 or the foreseeable future. This plan offers a tax credit of up to $2,500 per student in 2010, available up to 100 percent of the first $2,000 in qualified college costs and 25 percent of the next $2,000. To get the full credit, parents or students must spend at least $4,000 on qualified expenses.

The American Opportunity Credit applies to all families – even if they do not owe any federal taxes. Forty percent of the credit is refundable, so the family could receive a check from the government for an amount up to $1,000.

What’s Set to Expire?

The Hope and Lifetime Learning Credit is set to expire on Dec. 31. While there is speculation that Congress might extend the credit, it is not known when that will actually happen.

Originated during the Clinton administration, the Hope and Lifetime Learning Credit is available for married couples with modified adjusted gross income of up to $160,000. This credit carries with it the same threshold as the American Opportunity Credit of $4,000 on qualified expenses.

Based on the cost of an in-state college, it’s not hard to see how the $4,000 can be easily reached. However, many students attend two-year colleges where the tuition price tag is much less –an average of $2,544 per year in tuition and fees.

If you have cash on hand, prepaying tuition and expenses is a way to reach the $4,000 in qualified expenses before Dec. 31. For example, there are no rules prohibiting anyone from prepaying tuition. Most colleges post 2011 invoices before Dec. 31. If the bill is paid in 2010, taxpayers can claim the credit on their 2010 tax return.

Textbooks and course materials are qualified expenses in the American Opportunity Credit, so consider buying spring 2011 textbooks in 2010 and claim the credit on the 2010 return.

A special note on 529 college savings plans. Popular since they were created in 1996, the 529 plan helps families set aside money for future college costs. Withdrawals are tax-free if they are used for educational purposes, but if you take advantage of the American Opportunity Credit or the Hope and Lifetime Learning Credit, paying for college out of a 529 is considered double-dipping.

Instead, advisers suggest using a 529 plan to pay for costs that aren't covered by the tax credit, such as room and living expenses.

What Becomes Less Advantageous

As of Dec. 31, Coverdell Education Savings accounts will become much less attractive. Annual contributions will shrink to $500, tuition for primary and secondary schools will no longer be a qualified expense and a portion of withdrawals taken after Dec. 31 will be taxed.

Established in 2002, the Coverdell Account enables families to contribute up to $2,000 a year in a portfolio of mutual funds or other investments. These are classified as after-tax contributions, but withdrawals are tax free as long as the money is used for qualified expenses, including college-related costs or tuition at a primary or secondary school.

If you have a Coverdell account, you can roll it into a 529 college savings plan with no tax liability. Withdrawals from 529 plans are tax-free as long as the money is used for qualified expenses.

As always, it’s best to consult your accountant for the most current information.

Have a great October!

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These articles are intended to provide general resources for the tax and accounting needs of small businesses and individuals. Service2Client LLC is the author, but is not engaged in rendering specific legal, accounting, financial or professional advice. Service2Client LLC makes no representation that the recommendations of Service2Client LLC will achieve any result. The NSAD has not reviewed any of the Service2Client LLC content. Readers are encouraged to contact their CPA regarding the topics in these articles.

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