It’s application season, and not just for high-school and college seniors. The weak economy is also prompting older workers to return to school to refresh their skills or acquire new ones.
If you’re thinking of joining them, there’s good news: Uncle Sam can help ease the burden.
The tax code offers numerous breaks for education, from the American Opportunity Tax Credit and the Lifetime Learning Credit to 529 college-saving plans and the business deduction for work-related education. While none is a one-stop solution to the problem of paying for education—and many are mutually exclusive—they can make it easier to foot the bill.
The motivation for going back to school is simple: to land a better or more stable job. As The Wall Street Journal noted in a Monday article on companies’ difficulties filling job openings, 52% of employers surveyed by ManpowerGroup said they can’t find workers with the necessary skills—even as the unemployment rate sits above 9%.
Older workers are trying to tap into those opportunities by getting retrained. Between 2006 and 2009, according to the most recent data from the Department of Education, enrollment of students age 35 and older in post-high-school programs grew faster than enrollments of those 18 to 24.
Of course, education costs aren’t going down. According to data released this past week by the College Board, for 2011-12 the average price rose 4.5% at private colleges and more than 7% at public colleges—higher than the 3.6% overall inflation rate.
But more people are using tax breaks to ease the sting. In 2009, after Congress revamped a key credit, taxpayers claimed $14.7 billion in deductions and credits for undergraduate and graduate education—more than double the $6.6 billion in 2008, according to the most recent Internal Revenue Service data.
Unfortunately, navigating the tax code is no easy task. It takes IRS Publication 970, Tax Benefits for Education, 84 pages to explain 12 different benefits.
The American Institute of CPAs has called on Congress to simplify the current crazy-quilt of benefits enacted over many years. Until that happy day, taxpayers are stuck with the current system.
Here are tips on how to use the tax code to your advantage.
Who Gets What Help?
There are two main ways to ease your college costs: financial aid and tax breaks. People deemed affluent by the financial aid system and the tax code but who aren’t wealthy are often caught in two sets of cross hairs.
Experts say there is often little to no financial aid for families with income of more than $80,000 for instate public schools or $130,000 for private colleges, unless the family has more than one child in college. Then the limit could be close to $200,000 at some pricey private colleges.
Of course, some families may newly qualify for aid on income grounds due to the rocky economy. But the financial-aid system also looks at a family’s “balance sheet” and often asks for a contribution equal to 5.64% of parental assets and 20% of student assets per year. Retirement accounts and pensions are usually off limits for these calculations, but home equity may not be, especially at top private colleges.
Several tax benefits have income limits as well. Fortunately, some of those limits are higher than the limits for financial aid, and they don’t take a taxpayer’s assets into consideration.
The downside: There are precious few loopholes. For example, married couples who file separate returns, which lowers income, can’t claim some important tax breaks, including the American Opportunity Tax Credit, the Lifetime Learning Credit, the Student Loan Interest Deduction, or the Tuition and Fees Deduction (more about these breaks later).
But higher-earning families can benefit from the tax code’s treatment of other forms of aid. For example, income from merit scholarships usually isn’t taxable. And while, in theory, the portion of a grant attributable to room and board is taxable, “This is one of those benefits, like frequent flyer miles, the IRS almost never challenges,” says Douglas Stives, a CPA who heads the M.B.A. program at Monmouth University in New Jersey.
The same applies to students chosen as “resident advisers,” who receive remission of room and board fees.
Exploit Other Tax Benefits
Is there a family business, and a student willing and able to participate in it? Look for opportunities. Although the “kiddie tax” often imposes the parents’ rate on a student’s unearned income from investments, a young person’s earned income is taxed at regular tax rates. If a student provides more than 50% of his own support (including rent and tuition), he or she may qualify for tax credits that the parents earn too much to take.
The business might also be able to pay up to $5,250 of tuition. (See Employer-Provided Educational Assistance, below.)
Even if the child has no earned income, up to $1,900 of unearned income from investments is exempt from the kiddie tax, and the tax rate on long-term capital gains and dividends at that income level is zero.
The Best Breaks
Here’s a rundown of the most useful education tax benefits. Note that with the exception of the student-loan interest deduction, taxpayers are prohibited from “double-dipping,” or taking more than one tax break for the same expenses.
American Opportunity Tax Credit. This is one of the best benefits for those who qualify. It’s a dollar-for-dollar tax offset of up to $2,500 per student per year, for up to four years of undergraduate (but not graduate) education for students enrolled at least half-time in a degree program.
Up to $1,000 of the credit is “refundable,” meaning the family can get a check for that amount from Uncle Sam if no tax is due. If the taxpayer writes a tuition check in December for the spring semester, the credit may be claimed for that year’s taxes.
The credit can be used for books, supplies and equipment as well as tuition, but it can’t be claimed by anyone with a felony drug conviction.
For 2011, the benefit fully phases out at $90,000 of adjusted gross income (AGI) for most single returns and $180,000 for most joint returns. If the family can’t claim the credit and the student has earned income, some advisers suggest running the numbers to see if the student qualifies for the credit on his own.
Lifetime Learning Credit. While less generous than the American Opportunity Tax Credit, this is a useful tax offset of up to $2,000 for tuition and fees per year per family. It applies to graduate as well as undergraduate education, plus continuing-education courses taken to acquire or improve job skills.
The credit fully phases out at $122,000 of AGI for most joint returns and $61,000 for most single returns.
Qualified Tuition Programs (“529 plans”). 529 plans are often the best education benefit for taxpayers who don’t qualify for other breaks, in part because there are no income phaseouts. Individual donors (often parents and grandparents) may put up to $65,000 per beneficiary into a 529 plan once every five years, without gift tax consequences.
In 2008, President Obama and his wife used this provision to put $120,000 each into 529 plans for their two daughters.
529 plans are run by the states, which set terms and limits within federal guidelines; some give a tax deduction to in-state residents. There’s no federal deduction on money as it goes into an account, but the earnings are tax-free if used for either undergraduate or graduate tuition, fees, room, board, books and supplies. (For more, please see “529 Plans Roll Out New Perks,” Page B8.)
Grandparents often like 529 plans, because they control the account and can withdraw funds if circumstances change. (The earnings portion of a withdrawal are subject to a 10% penalty and are taxable.) So if a grandparent stocks a 529 account with $50,000 but later needs the money for medical bills, he or she can reclaim the money.
What’s more, 529 funds aren’t considered part of an estate. While federal taxes don’t matter for many while the estate tax exemption remains $5 million per individual, many states still have significant estate taxes.
It’s often possible to change a 529 account’s beneficiary, so if Mom or Dad wants to go back to school, the plan could be shifted; check your state’s rules. Because of the double-dipping rules, taxpayers with 529 plans who also qualify for another credit will want to use the credit first and then withdraw remaining funds from the 529 plan.
For example, if qualified college costs come to $12,000 after merit scholarships and there’s a sizeable 529 plan, pay the first $4,000 out of pocket in order to preserve the American Opportunity Tax Credit, and then withdraw the rest from the 529 plan.
Many 529 plans are currently “underwater” because of high fees or poor market performance over the last decade. In that case, the taxpayer may close the account without penalty or tax. A net loss can be taken as a miscellaneous deduction.
Business Deduction for Work-Related Education. This deduction allows a full write-off for tuition, fees, transportation and other expenses. There is no dollar limit on the size of the deduction, nor is there any income phase-out.
There’s a big catch, however: The education can’t qualify the taxpayer for a new trade or business, such as a law, medical, or nursing degree. An advanced law degree or an M.B.A. can work, if the taxpayer isn’t switching fields. Mr. Baker, the small-business adviser in Washington, is writing off the costs of his Masters degree at American University, plus transportation.
“Many of my students have claimed this deduction with success, even when it has been challenged by the IRS,” says Robert Willens, an adjunct professor at Columbia University’s Business School.
Student-Loan Interest Deduction. Interest paid on student loans for tuition, room and board, transportation and other expenses may be deductible up to $2,500 per year, depending on the type of loan, if the student was enrolled at least half-time in a degree program. It applies to debt from graduate and undergraduate programs.
The benefit fully phases out by $150,000 of AGI for most joint returns and $75,000 for most single returns.
Employer-Provided Educational Assistance. Both an employer and an employee may exclude up to $5,250 from tax per year for payments for education. The exclusion applies to undergraduate and graduate tuition, and there’s no income phaseout. No payroll tax is due on the payment, either, and the aid may be used for books and supplies as well as tuition.
Philip Vogt, a 28-year-old M.B.A candidate at Monmouth University in New Jersey, is using this benefit. He works at a division of Parexel International, a clinical research firm, and wants to add accounting skills to his degree in management. “It’s a great benefit for an employer to offer,” he says.
To offer it, the employer must have a “127 plan” in place, and it must be publicized to all employees. A family business might be able to provide this assistance to a relative who works in the business, if he or she doesn’t own 5% or more of the business. “Check with an expert about age requirements and other issues,” says Monmouth’s Mr. Stives.
Tuition and Fees Deduction. Experts suggest thinking twice before taking this $4,000 deduction for tuition and fees. In most cases, the offset of a tax credit is more valuable.
“A bigger number doesn’t mean a bigger benefit,” says Melissa Labant of the American Institute of CPAs.
This deduction available for graduate as well as undergraduate education, and it fully phases out at $160,000 for most joint filers and $80,000 for most single filers.
Early IRA Distribution. Early withdrawals from a traditional IRA (usually before age 59½) that are used for education aren’t subject to a 10% penalty. The payout can be used for books, supplies, and room and board (if at least a half-time student) as well as tuition.
The problem: Full income tax is due. And “once assets are out of an IRA, they can’t be put back,” says Mr. Carpenter. “I advise against this.”
Written by Laura Saunders at firstname.lastname@example.org