College Education Expenses, Credits, and the New Graduate

July 1st, 2012

Congress and the last two presidents have put legislation into effect that makes the payment of college education expenses a potentially lucrative tax savings tool. Parents and college students should plan carefully so that they maximize these tax savings. Unfortunately, figuring out which credits and deductions are available can be very complex. For example:

1. The three tax credits (American Opportunity, Hope, and Lifetime Learning) are worth as much as $2,000 to $2,500 each year.
2. The Hope and Lifetime credits are not “refundable.” That means that you can use them only to the extent that you have a tax liability. This is not much help for a recent graduate who is either earning little or, possibly nothing and therefore has little or no tax liability.
3. If the tax credits are unavailable, then you have the option of reducing your taxable income by up to $4,000 for college expenses. This is valuable because it reduces the exclusions under health and miscellaneous deductions as well as the alternative minimum tax.

In the year a student graduates from college, additional considerations come into play:

1. Who can claim the dependent exemption for the graduate-the parents or the graduate?
2. How does dependent status affect eligibility for each type of education incentive?
3. What should parents do with unused College Savings Plan balances?

The answer to each of these questions is, “It depends.” Some of the issues on which answers hinge are:

1. How many months the graduate was a full-time student during the year. The magic number is at least five calendar months for purposes of determining dependency.
2. Is the graduate married, or will he or she be married any time in the current year? If married, will he or she file with a spouse for a refund?
3. How old is the graduate? The magic number is younger than age 24.
4. How much combined income do the parents make? The income phase-out is different for each education credit or deduction. For example, for the American Opportunity Credit a married couple with combined income between $160,000 and $180,000 will see a gradual phase-out of this credit. At $180,000 (2011 numbers), parents will not be able to use any of the American Opportunity Credit.

It’s not possible for us to give you simple rule-of-thumb answers to these tax planning issues. We must review your particular situation and plan accordingly. Let us help you. Give your BWFA tax advisor a call at 410-461-3900.