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Shoptalk Online 194, March 4, 2003
 

Federal updates

Benefits of higher education include tax relief

This article outlines some of the tax benefits currently available to students and parents who invest in higher education. You may wish to share this information with the students and parents you serve. Please feel free to copy or reprint the article and distribute it to your customers.

For many students and their parents, tax season is a time of grumbling and groaning. Forms, paperwork, and the April 15 tax filing deadline can add stress to an already hectic life. But if you're paying off student loans or paying for college tuition and fees, your higher education investment might help you in a way you didn't expect—by reducing your tax bill.

There are three higher education related tax benefits that students and parents may be able to take advantage of:

  • The student loan interest deduction benefit can reduce the taxable income of many student and parent loan borrowers based on the amount of interest the borrower paid over the tax year.
  • The tuition and fees deduction, new for the 2002 tax year, can reduce the taxable income of taxpayers based on college tuition and fees paid during the tax year.
  • The Hope and Lifetime Learning tax credits allow many taxpayers to claim a credit against their federal income taxes for college tuition and fees paid during the tax year.

Student loan interest deduction
Both student and parent borrowers may claim the student loan interest deduction, under which borrowers may deduct interest payments they made on their higher education loans during the 2002 tax year. The deduction allows borrowers to decrease their total taxable income by as much as $2,500.

The student loan interest deduction can be of particular value to recent college graduates. Unlike tax credits, which require that a taxpayer earn a large enough income to take advantage, the student loan interest deduction actually reduces the amount of the borrower's income subject to federal taxes prior to the application of other tax deductions. This is especially good news for those only a few years out of college who, whether due to newness to the workforce, the slow economy, or both, may not earn enough income to be able to take advantage of the higher education tax credits.

The IRS allows a taxpayer to claim the deduction for interest amounts paid on loans taken out for that taxpayer, the taxpayer's spouse, or someone who was a dependent of the taxpayer at the time the loan was taken out.

To count towards the interest deduction, the interest paid must have been for a loan obtained only for the payment of college tuition and qualified related expenses. Typically the interest deduction is applied to interest on federal student loans such as Perkins, Stafford, PLUS, and Consolidation loans.

Revolving lines of credit such as credit card debt may also qualify when used by a borrower exclusively to pay qualified higher education expenses. In addition, interest paid on loans even when interest payments are not required, such as when a Stafford loan is in deferment status, can also qualify.

A tax filer's income level may affect the amount he or she may claim as a deduction. Any limitation on the amount of the deduction is determined through calculation of the modified adjusted gross income (AGI). A tax filer's AGI is calculated as part of completing a tax return.

For income tax returns due on April 15, 2003, the following limits apply:

  • A single filer whose AGI for 2002 is $50,000 or less is eligible to receive the full deduction; a filer with an AGI between $50,000 and $65,000 is eligible for a reduced deduction.
  • For a married couple filing a joint return, the AGI threshold to receive a full deduction is $100,000; the reduced deduction applies to couples with an AGI between $100,000 and $130,000.
  • A single filer whose AGI is $65,000 or greater is not eligible to receive the student loan interest deduction. The same is true for a married couple with an AGI of $130,000 or more.
  • A taxpayer whose tax filing status is married filing separately from his or her spouse is not eligible to claim the deduction.

Tuition and fees deduction
The tuition and fees deduction allows a taxpayer to deduct as much as $3,000 from his or her taxable income for tuition and fees paid for the taxpayer, his or her spouse, or his or her dependents. The eligibility requirements for claiming the tuition and fees deduction, including limits based on total adjusted income, generally mirror those for the student loan interest deduction.

The qualified tuition and related expenses that may be applied towards the tuition and fees deduction are those amounts paid in 2002 for enrollment during that year or for an academic period beginning any time from January 1, 2002 to March 31, 2003. The deduction may not be claimed for amounts applied towards either the Hope or Lifetime Learning tax credits.

In most cases, both the student loan interest and tuition and fees deductions may be claimed by filing either Form 1040 or Form 1040A, known respectively as the long-form 1040 and short-form 1040. Taxpayers wishing to claim either deduction will not be able to do so using Form 1040EZ, "Income Tax Return for Single and Joint Filers With No Dependents."

Hope and lifetime learning tax credits
The Hope and Lifetime Learning tax credits, though not necessarily as simple in application as the deductions, can provide important help to families and individuals juggling the often considerable cost of paying for college. Both credits are claimed for qualified tuition and related expenses paid during the tax year, but there are important distinctions between the two.

The Hope Credit is available only for the first two years of a student's higher education for a maximum of $1,500 per year. The Lifetime Learning Credit is available for all years of a student's higher education for a maximum of $1,000 per year.

Other important differences between the two credits include:

  • The Hope Credit maximum of $1,500 is for each eligible student listed on a return, while the Lifetime Learning Credit maximum of $1,000 is per tax return.
  • Students for whom the Hope Credit is claimed must be pursuing an undergraduate degree or other recognized education credential, but students for whom the Lifetime Learning Credit is claimed are not required to be in a degree program.
  • Students for whom the Hope Credit is claimed must be enrolled at least half-time for an academic period that began during the tax year, while the Lifetime Learning Credit is available for any student taking one or more college courses, including courses to improve job skills.
  • The Hope Credit may not be claimed for any student who had a felony drug conviction on his or her record at the end of the tax year, whereas the Lifetime Learning Credit carries no such restriction.

Only one credit can be claimed against higher education expenses for a particular tax year. Also, neither credit may be claimed if a taxpayer chooses to utilize the student loan interest deduction.

As with the income tax deductions, the Hope and Lifetime Learning credits are subject to income limits based on a tax filer's AGI. For tax year 2002:

  • A tax filer with an AGI below $41,000 is eligible to claim the full credit.
  • A tax filer with an AGI between $41,000 and $51,000 or a couple filing a joint return with an AGI between $82,000 and $102,000 is only eligible to claim a reduced credit.
  • An individual with an AGI of $51,000 or more or a couple with an AGI of $102,000 or more is not eligible to claim either the Hope or Lifetime Learning tax credits.

To claim either credit, a tax filer must complete and submit Form 8863, "Education Credits (Hope and Lifetime Learning Credits)," with his or her tax return.

What are qualified higher education expenses?
Tuition and mandatory fees paid to a college or university are considered qualified expenses for the purposes of the higher education tax benefits. However, student activities fees, as well as costs for books, supplies or equipment may not be applied towards the credits unless they are paid directly to the college or university as a condition for enrollment. Personal expenses, even when related to college attendance, do not qualify.

Higher education tax benefits history
The Hope and Lifetime Learning tax credits and the student loan interest deduction were created as a part of the Taxpayer Relief Act of 1997, enacted on August 5, 1997. These benefits were added to ease the burden of paying for college placed on families and students, especially middle-class families who might not qualify for need-based aid but may still be struggling with the cost of college.

The Economic Growth and Tax Reconciliation Act of 2001 added the tuition and fees deduction and raised the applicable income limits, expanding eligibility for the existing higher education tax benefits to include a larger number of Americans.

Get more information!
Publication 970, published on an annual basis by the IRS, is the official guide to understanding federal higher education income tax benefits, providing important instructions and guidance and detailing the full eligibility requirements for each benefit. In addition to the tax credits and deductions discussed above, Publication 970 elaborates on the other higher education related tax benefits that are available.

The instruction booklets for forms 1040 and 1040A also include instructions on how the various tax benefits should be applied to an individual tax return.

These publications—along with a great deal of other tax information and guidance—are available on the IRS website at www.irs.gov. The IRS also offers taxpayers free answers to tax questions at 1-800-TAX-1040 (829-1040).

The Texas Financial Aid Information Center, staffed by the knowledgeable professionals on the TG customer assistance team, can help you in understanding the higher education tax benefits that might be available to you. To contact the Information Center, call (877) 782-7322 toll free or ask your question online at www.collegefortexans.com/comments.

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