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There are federal income tax benefits concerning saving for college costs, paying college costs, and repaying educational loans. The following information is provided as a summary of these benefits to assist you in planning for college financing. Because tax laws may change, please refer to your tax accountant for other tax laws and more detail on how these benefits will impact your personal taxes. The National Association of Student Financial Aid Administrators (NASFAA) has published an updated "Parent and Student Guide to Federal Tax Benefits for Tuition and Fees" for the 2006 tax year. You can access the NASFAA Guide at http://www.nasfaa.org/annualpubs/TaxBenefitsGuideIntroPS.html
You may also refer to the Internal Revenue Service's web site www.irs.gov for a more detailed description of tax benefits concerning higher education.
The Taxpayer Relief Act of 1997
The new student loan interest deduction benefits any taxpayer that is currently in repayment on an educational loan for college expenses of the taxpayer, the taxpayer's spouse, or the taxpayer's dependent as long as the loan was taken for at least half-time enrollment. Interest paid on educational loans can be deducted up to $2,500. This deduction is allowed even if the taxpayer does not itemize other deductions on Schedule A of a Form 1040. A taxpayer's eligibility is phased out if their modified adjusted gross income is between $50,000 to $65,000 for single filers and between $100,000 to $130,000 for joint filers.
The Hope Scholarship Credit
The Hope Scholarship Credit is a nonrefundable tax credit for out-of-pocket tuition expenses, defined as expenses not paid by tax-free scholarships and/or tax-free employer-provided assistance. The Hope Scholarship Credit has a maximum of $1,500 per student for each of the first two years of post-secondary education. The amount of the credit is calculated by allowing a credit for the first $1,000 of out-of-pocket tuition expenses and 50 percent of the second $1,000. Expenses can be for the taxpayer, the taxpayer's spouse, or the taxpayer's dependent(s) if the student is enrolled at least half time for at least one academic period in a degree or certificate program and free of a drug-related conviction. The program is phased out on a sliding scale between $40,000-$50,000 modified adjusted gross income for single filers and between $80,000-$100,000 for joint filers. Only the tax filer who claims the student as a dependent can claim the credit; students may claim the credit if they are not claimed as dependents by another taxpayer. Married taxpayers filing separate returns are not eligible for the credit. Credit cannot be claimed for the same student for more than two years.
The Lifetime Learning Credit
The Lifetime Learning Credit provides a tax credit equal to 20 percent of the first $10,000 of out-of-pocket tuition expenses for all students to a maximum of $2,000. Taxpayers cannot claim both the Lifetime Learning Credit and the Hope Scholarship Credit for the same student in the same tax year. This credit is available for an unlimited number of tax years for any enrollment and any program at an eligible institution. The program is phased out on a sliding scale between $40,000-$50,000 modified adjusted gross income for single filers and between $80,000-$100,000 modified adjusted gross income for joint filers.
Education IRAs
Cloverdell education savings accounts (formerly called Education IRAs) are now available as well as penalty-free withdrawals from other IRAs for educational expenses. Beginning with 2002, families can now contribute $2,000 per year for each child under 18 years of age. However, families can now contribute for special needs beneficiaries after their 18th birthday in the child's name (contributions are not tax deductible) to a Cloverdell education savings account. Tax-free earnings in the Cloverdell education savings accounts will accumulate, and no taxes will be due upon withdrawal if the funds are used for out-of-pocket educational expenses. A taxpayer's eligibility to contribute to the Cloverdell education savings accounts is phased out between $95,000-$110,000 modified adjusted gross income for single filers and $190,000-$220,000 modified adjusted gross income for joint filers. In addition, at age 30, the child's Education IRA must be closed or transferred to a younger family member (unless the initial beneficiary is a special needs child). Please note that effective with 2002 you may be able to claim the Hope or the Lifetime Learning credits in the same year that the student receives a tax-free withdrawal from an Education IRA. However, you cannot use the expenses on which the credit is based to determine the taxable portion of the withdrawal from the Cloverdell account.
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