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Education Provisions Under the New 2001 Tax Law August
2001 |
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The Economic Growth and Tax Relief Reconciliation
Act of 2000 offers significant tax reductions for most tax payers. |
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As
we approach the fall of the year, it is especially of interest to all
parents who have children either in high school or in college to become
thoroughly familiar with these education provisions of this tax law. 1.
Modification of education IRAs. The
tax law currently allows a taxpayer to make nondeductible contributions
to an Education IRA for the purpose of paying the future higher
education expenses (post
secondary tuition, fees, books, supplies, and equipment) of a designated
beneficiary. Annual
contributions to all Education IRAs for a beneficiary may not exceed
$500 and may not be made after that beneficiary reaches age 18.
The $500 contribution limit
is phased out ratably for taxpayers with AGI between $95,000 and
$110,000 ($150,000 to $160,000 for joint filers).
Taxpayers with AGI exceeding the higher amount are not allowed to
contribute. Education IRA
distributions for qualified higher education expenses are excluded from
income. If distribution are greater than expenses in a year, then a
portion of the distributing is subject to income tax plus a 10%
additional tax penalty (some exceptions apply).
Distributions generally must be made by the time the beneficiary
reaches age 30. Effective
for tax years starting after 2001, the new law: ·
Increases
the annual limit on contributions to an Education IRA to $2,000 per
designated beneficiary. ·
Expands
the definition of qualified education expenses to include expenses for
qualified elementary and secondary school
(grades K-12; public, private, or religious) and to include
certain room and board expenses, uniforms, computers, and extended day
program costs. ·
Increases
the contribution phase out range for single filers (I.e., to between
$190,000 and $220,000 of
AGI for joint filers). ·
Eliminates
the age 18 restrictions on contributions for beneficiaries and the age
30 distribution rule in cases where a beneficiary has “special
needs,” to be defined in regulations. ·
Clarifies
that corporations and other entities (including tax-exempt
organizations) may contribute to Education IRAs. ·
Coordinates
the HOPE and Lifetime Learning Credits for education expenses with the
exclusion for Education IRA distributions so there is no dual tax
benefit for the same expenses. ·
Eliminates
the 6% excise tax on Education IRA contributions are made to a qualified
state tuition program on behalf of the same beneficiary. 2.
Qualified
Tuition Programs. Also
called college savings plans or “Section 529 plans,” these
state-sponsored tuition programs offer parents and other taxpayers a
tax-favored means of funding a child’s future qualified higher
education expenses. Under
current law, earnings accumulate tax deferred and generally are taxable
to the beneficiary (rather than the parent or other person who
established the plan) when funds are distributed to pay expenses or
education benefits are received. The
beneficiary (or person allowed to claim the beneficiary as a dependent)
may claim a HOPE or Lifetime Learning Credit for the tuition and related
expenses paid with the distribution, if otherwise eligible. For
tax years starting after 2001 (unless noted), the new tax law: · 1
Allows
educational institutions (public or private) to sponsor prepaid tuition
programs that satisfy the Section 529 requirements. · 2
Makes
distributions or education benefits received from qualified tuition
received from qualified tuition programs excludable from income,
starting in 2002 for state programs and in 2004 for qualified tuition
programs maintained by an entity other than a state. · 3
Coordinates
this income exclusion with the HOPE and Lifetime Learning Credits so
that the tax-free distribution cannot be used for the same expenses for
which a credit is claimed. · 4
Sets
limits on the room and board allowance that may be paid with tax-free
distributions. · 5
Imposes,
after 2003, a 10% additional tax penalty on Section 529 program
distributions included in income. · 6
Allows
tuition credits or other
amounts to be transferred tax free from one qualified tuition
program to another qualified program for the same beneficiary. · 7 Expands the definition of “member of the family” for purposes of inter-family changes of designated beneficiaries to include first cousins of the original beneficiary.
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3.
Employer-Provided Educational Assistance. Employer-paid
educational expenses are generally deductible by the employer and are
excludable from the employee’s income, up to $5,250 annually (if
certain requirements are met). The
exclusion does not apply to graduate courses and is scheduled to expire
with respect to undergraduate courses that start after December 31,
2001. The new law extends
the exclusion to graduate courses and makes the exclusion for
undergraduate and graduate course permanent, effective for courses
starting after 2001. 4.
Student Loan Interest Deduction. Within
limits, interest paid on qualified education loans is tax deductible.
The deduction, which may be claimed whether the taxpayer itemizes
or not, is allowed for up to $2,500 of interest paid each year during
the first 60 months in which interest payments are required.
Voluntary payments of interest do not qualify.
Eligibility for the deduction is phased out for taxpayers with
AGI of $40,000 to $55,000 for unmarried taxpayers and $60,000 to $75,000
for joint filers (to be adjusted for inflation after 2002).
After 2001, the new law repeals the 60-month limit, as well as
the restriction that voluntary interest payments are not deductible.
The income phase out ranges increase to $50,000 to $65,000 for
unmarried taxpayers and to $100,000 to $130,000 for married couples
filing jointly. 5.
Deduction
for Higher Education Expenses. In
general, education expenses are not tax deductible. (Certain exceptions exist — for example, if the education
qualifies as an employee business expense.)
And, while the HOPE and Lifetime Learning Credits are available
for qualifying expenses, in some cases a deduction for the expenses
would provide a greater tax benefit. Recognizing
this, Congress included in the new law a new deduction for qualified
higher education expenses (defined in the same manner as for the HOPE
Credit) that are paid during the year.
The deduction may be claimed whether or not the taxpayer itemizes
deductions. However, no
education expense deduction may be claimed in a year in which a HOPE or
Lifetime Learning Credit has been claimed for the same student.
The maximum amount of the deduction — and the maximum income a
taxpayer may have and still claim the deduction — is as follows: Those with AGI exceeding the maximums (and married –separate filers) may not claim any deduction. The deduction expires for tax years beginning after 2005.
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