Higher Ed Expenses and Tax-Advantaged Accounts. A Quick Reminder for Parents

A big focus for Overman Capital is helping clients with their family's education-saving goals. As we mentioned in an earlier post, due to the rapidly rising cost of college, we're receiving more and more questions about how to save for a child or grandchild's secondary education. We're taking the opportunity to give you a brief overview of what educational expenses qualify for a reduction in your taxes, as well as share some tax-focused saving strategies. 

Parents and grandparents of high school students have a nostalgic feeling about the child they've watched grow up, as well as a concern for what lies in their future. It's only natural to help that future scholar navigate the financial hurdles to an excellent education. That said, you have a few obstacles of your own. It would be good to know how to financially help the child in your life while avoiding any extra tax burdens. 

What School Expenses Qualify?

If you’re helping your child fund their education, the IRS offers education credits. These can be claimed for qualified expenses paid with cash, check, credit card, debit card, or with loan money. However, if you are paying with money from a loan, your credit applies only to the year you make the payment.¹

These qualified expenses include:²

• Tuition
• Fees
• Related expenses required for enrollment or attendance
• Expenses covered by the American Opportunity Tax Credit (AOTC)

Bear in mind; the AOTC has phase-out limits for households with a modified adjusted gross income of over $160,000 for married couples filing jointly or $80,000 for single filers. You can still get a partial credit up to the total phase-out limit of $180,000 for couples or $90,000 for those filing as single.²

For those who qualify, the AOTC offers up to a $2,500 credit on items assigned for study, such as:²  

• Books
• Supplies
• Equipment

Per the IRS Publication 970, "expenses for books, supplies, and equipment needed for a course of study are included in qualified education expenses whether or not the materials are purchased from the educational institution."

What Expenses Aren’t Qualified?

Expenses for sports, games, hobbies and courses without credit are not qualified. However, there is an exception for these expenses if they are necessary for the student’s degree.¹

The following items are not qualified, even in situations where you’re paying the school directly for them:¹  

• Room and board
• Insurance
• Medical expenses/student health fees
• Transportation
• Personal, living or family expenses (such as meals)

It's also important to remember that if you're taking money from a tax-advantaged account, a scholarship, or a grant with no tax requirements, you're disqualified for the amounts used. For instance, if the student in question had a $5,000 scholarship, you'd subtract that amount before taking any deductions.¹ 

Tax-Advantaged Accounts

As you consider how you'll cover college costs, starting with tax-focused saving strategies can help. Here are several college savings vehicles with important tax considerations Overman Capital believes you want to consider.

529 College Savings Plans

Offered by states and some educational institutions, these plans allow you to save up to $15,000 per year for your child’s college costs without having to file an IRS gift tax return. A married couple can contribute up to $30,000 per year. However, an individual or couple’s annual contribution to a 529 plan cannot exceed the yearly gift tax exclusion set by the IRS.³ You may be able to front-load a 529 plan with up to $75,000 in initial contributions per plan beneficiary - up to five years of gifts in one year - without triggering gift taxes.⁴ Unlike the tax deductions above, 529s can be used for books, supplies, equipment, room and board, and even computers or tablets and education software.

Remember, a 529 plan is a college savings plan that allows individuals to save for college on a tax-advantaged basis. Rob and Jay believe state tax treatment of 529 plans is only one factor to consider prior to committing to a savings plan. They believe you should evaluate the fees and expenses, investment options, and performance associated with a particular plan. Whether a state tax deduction is available will depend on your state of residence (note that NC does NOT offer in-state tax deductions for contributions to NC 529 plans). State tax laws and treatment may vary. State tax laws may be different than federal tax laws. Earnings on non-qualified distributions will be subject to income tax and a 10% federal penalty tax.  

529 plans have some nice flexibility built into them: if your child doesn’t want to go to college, you can change the beneficiary to another child in your family. You can even roll over distributions from one 529 plan into another 529 plan established for the same beneficiary (or another family member) without tax consequences.^3,4

Grandparents can also start a 529 plan or other college savings vehicle. In fact, anyone can set up a 529 plan on behalf of anyone. You can even establish one for yourself.^3,4

Coverdell ESAs

Single filers with modified adjusted gross incomes (MAGIs) of $95,000 or less and joint filers with MAGIs of $190,000 or less can pour up to $2,000 into these accounts annually.⁵ If your income is higher than that, phase-outs apply above those MAGI levels. You can use Coverdell ESA funds for college or K-12 education expenses. They cover the items mentioned above for 529s and can even be extended to tutoring and transportation related to education.⁵

Contributions to Coverdell ESAs aren’t tax-deductible, but the accounts enjoy tax-deferred growth and withdrawals are tax-free, so long as they are used for qualified education expenses (similar to 529's). Contributions may be made until the account beneficiary turns 18. The money must be withdrawn when the beneficiary turns 30 or taxes and penalties may occur.^5,6

UGMA & UTMA accounts

These all-purpose savings and investment accounts are often used to save for college. They take the form of a trust. When you put money in the trust, you are making an irrevocable gift to your child. You manage the trust assets until your child reaches the age when the trust terminates (i.e., adulthood). At that point, your child can use the UGMA or UTMA funds to pay for college; however, once that age is reached, your child can also use the money to pay for anything else.⁷

Using a trust involves a complex set of tax rules and regulations. Before moving forward with a trust, consider working with Overman Capital or other professionals who are familiar with the rules and regulations.

With the right kind of college planning, your kid(s) could graduate from college debt-free. Can you imagine? Give Rob and Jay a call today at (252) 635-6666, connect with us online, or stop by the office in New Bern to discuss these savings methods and others.