We plan for retirement, we plan to go on vacations, and most of us will say that we plan for our children’s education, but are we really? As we approach another school year, let’s take a look at what we can do now for today’s costs, but also what we can do to help minimize our costs for years ahead. For today’s costs, in particular, I want to discuss tax planning for the 2012 expenses you might be able to take as tax deductions and tax credits on your 2012 income tax return. And then for those costs that will come after 2012, I want to discuss some of the tax advantaged ways you can plan for college.
While many of the current tax deductions and tax credits focus on college expenses (or post-secondary education), there is a way to help pay for qualified education expenses for elementary and secondary schools (i.e. kindergarten to 12th grade) for public, private or religious schools. For your children or grandchildren, you can set up a Coverdell Education Savings Account (CESA). In 2012 you can contribute up to $2,000 to a Coverdell Education Savings Account (CESA). For 2013 the contribution is scheduled to drop back to $500, unless Congress extends the $2,000 limit another year, as they did last year. This is a great planning opportunity if you have children under the age of 7 and you know you want them to attend a private elementary school. Or, if you have children under the age of 10 and you know you want them to attend a private high school. There are some restrictions, but the main items are the beneficiaries of the account have to be under age 18 at the initial contribution, but if this is for a special needs child, there are no age limitations. There are also income limitations. You won’t be able to contribute if you earn more than $190,000 and you file your income tax return as Married Filing Jointly or if you earn more than $110,000 and you file as Single or Head of Household on your tax return. If the funds are not used up, the account can be rolled over to another beneficiary who is a family member, including family members of in-laws. Once the beneficiary reaches the age of 30, the account has to be either rolled over to another beneficiary or distributed out.
If you want to save for college expenses for your children, no matter what their age is today, my recommendation is to just start. One of the best options out there is a 529 Plan. Many financial planners and institutions can get you information on these types of accounts and most states have a 529 Plans where you can invest directly. My tax planning point for you here is that the contributions in the 529 plans grow tax deferred. And, as long as you use these funds for qualified higher education expenses, any withdraws from the account will be tax free. There are no income limitations with a 529 Plan like the CESA discussed above. Contributors maintain control of the funds until the distributions are made to the beneficiary and the contributor can change the beneficiary. Contributions are considered gifts therefore the annual gift exclusion applies, meaning you can contribute up to $13,000 before a gift tax return would be required. However, there is not a limitation on what can be contributed, so even contributions of $100,000 can be made, pending restrictions placed on the account by 529 Plan administrator. For any contribution greater than $13,000 a year, I recommend you work with your accountant and estate attorney on specific details.
And finally, Tax Credits. If you have college age or very soon to be college age children, then you need to consider the available tax credits you can take on your income tax returns. The two main credits for today’s college expenses are the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC). The AOTC provides for a refundable tax credit. Keep in mind I said refundable, meaning you can get money back. The AOTC is capped at $2,500 per student. The tax credit will provide a 100% credit for the first $2,000 of qualified higher education expenses, and then 25% of the next $2,000 of qualified higher education expenses. So for the first $4,000 of qualified expenses, you can get a refundable credit of $2,500. The AOTC is available for the first four years of a student’s post-secondary education. Keep in mind, there are income limitations to this credit as well. You won’t be able to take the full credit if you earn more than $160,000 and you file your income tax return as Married Filing Jointly or if you earn more than $80,000 and you file as Single or Head of Household on your tax return.
After the first four years, the next best credit for qualified education expenses is the Lifetime Learning Credit (LLC). This credit is available for everyone, not just students, and there are far fewer restrictions. For one, the student does not have to be enrolled in a degreed program, or be considered a half-time student. The credit can be used for undergraduate, graduate or even courses for professional development. The main limitations on this credit are that the expenses should be for qualified tuition and fees, and the credit calculation is based on 20% of the first $10,000 of expenses. You won’t be able to tax this credit if you earn more than $102,000 and you file your income tax return as Married Filing Jointly or if you earn more than $51,000 and you file as Single or Head of Household on your tax return.
A final planning point here is that even if your income keeps you from qualifying for the AOTC or LLC tax credits, consider having the student take these credits. While there are other income tax return considerations, and you should always consult with your accountant, always consider the options. Don’t let you concerns about how much you earn (or don’t earn) keep you from planning for education expenses. The tax law provides many ways to save and even get money back.
Tax planning should be part of any budget plan, but you have to start. Proverbs 24:3-4 provides that, “by wisdom is a house built, by understanding is it made firm; and by knowledge are its rooms filled with every precious and pleasing possession.”
