Calculating Education Benefits

Posted: Monday, January 20, 2003

WASHINGTON (AP) -- Taxpayers will find a new deduction for 2002 college expenses and tax law changes that make it easier to save for education and to manage state tuition savings plans known as 529s. There's also a pair of education tax credits that can be subtracted from your tax bill.

But it's not easy to navigate the thicket of changes that went into effect last year for education expenses. Income ceilings usually apply, and you may wish to look ahead to 2003's education costs or consult a tax professional to see what tax benefits are best to take in 2002.

For a quick summary of education tax benefits, see the chart on page 55 of IRS Publication 970, ''Tax Benefits for Education,'' available online at or by calling 1 (800) 829-3676 (1-800-TAX-FORM).

At the top of the list of new benefits: a deduction of up to $3,000 for last year's college or post-secondary tuition and fees for a taxpayer, spouse or dependent. But only taxpayers with incomes of up to $65,000 for single filers or $130,000 for couples filing jointly can claim the deduction.

Another cost that can be deducted: Up to $2,500 of interest paid on an education loan. Before 2002, only the first 60 months of interest on a loan repayment could be deducted. That limit was removed for 2002. Here, too, income limits apply. See Publication 970.

Two tax credits -- not new but an important part of 2002 education tax benefits -- are available for taxpayers with higher education expenses.

Unlike deductions, which reduce the income on which your tax is figured, credits reduce your tax dollar for dollar and are subtracted directly from tax owed. But you can't take both the $3,000 deduction and credits; you'll have to choose what's best for your tax situation.

The Hope tax credit allows taxpayers to claim up to $1,500 for tuition and related expenses ($1,000 for the first $1,000 of expenses and $500 for the next $1,000 of expenses). But the credit can be taken only for students in their first two years of college or other post-secondary education. A student must have been enrolled in a degree or certificate program for at least one academic period beginning in 2002 and must have carried at least half of what the school considers a normal academic workload.

The Lifetime Learning credit can be taken at a rate of 20 percent of the first $5,000 of qualified expenses, up to a maximum credit of $1,000 per tax return (not per student) for 2002. There is no limit on the number of years this credit may be taken, and there is no enrollment requirement for the Lifetime Learning credit -- it may be claimed for a single course. For the 2003 tax year, the credit goes to $2,000 on $10,000 of qualified expenses.

You cannot claim both the Hope and Lifetime Learning credits in the same year for the same student. So if a student is in the first two years of college, you may wish to use the Hope credit for that student this year and consider taking the Lifetime Learning credit in a subsequent tax year. For both credits, income ceilings apply.

Before the credit or deduction is taken, eligible education expenses must be reduced by the amount of tax-free benefits. For example, if a taxpayer had $10,000 of qualified tuition expenses in 2002, but $9,000 of those expenses were covered by a nontaxable scholarship, only $1,000 is available for the education credits.

Other tax news for 2002: The limit on contributions to a child's Coverdell Education Savings Account, formerly known as an education IRA, increased from $500 to $2,000, making such accounts more attractive education savings vehicles.

Earnings on ESAs are tax-deferred and can be tax-free -- along with distributions -- if used for qualified education expenses. For 2002, qualified education expenses were expanded to include those for accredited elementary or secondary public, private or religious schools.

Also new this year: Contributions can be made as late as April 15, 2003, and still count for 2002. You can contribute to ESAs only for children under the age of 18, unless the child has a disability or other special needs.

Many people save for college by participating in what IRS calls ''qualified tuition programs,'' the prepaid tuition and savings plans known as Section 529s, which are set up through states or eligible private institutions.

Earnings on the state accounts, along with distributions, are tax-free if used for qualifying education expenses. Distributions for 529s set up by private institutions won't be tax-free for qualified expenses until the 2004 tax year, however.

Contributions to qualified tuition programs aren't deductible from a taxpayer's federal taxes, although many states grant deductions on state income taxes for contributions to their own 529 plans.

New this year: You no longer have to stay with a particular 529 plan if a better one comes along. A 529 can be rolled over to another qualified tuition plan once in a 12-month period without incurring a tax obligation. A 529 also can be rolled over to another beneficiary, as long as that person is a close relative of the current beneficiary. (A handy Internet guide to Section 529 plans is available at

A taxpayer can exclude from taxable income up to $5,250 of employer-provided assistance for education expenses, which in 2002 can include expenses for graduate courses as well as undergraduate courses.

Interest on qualifying U.S. government savings bonds (series EE and series I) continue to be excluded from taxable income if used for education expenses, though there are income limitations. Education scholarships and fellowships received by a degree candidate are not taxed. Also, distributions from regular IRAs and Roth IRAs are not subject to early withdrawal penalties if the distribution is used to pay qualifying education expenses for you, your children or grandchildren.

One caution for do-it-yourselfers: Don't use the same education expenses as a basis for claiming multiple education tax benefits. For example: You purchased textbooks for $1,000 using a distribution from an ESA. You cannot use that same $1,000 expense as the basis for a $1,000 tax deduction for education expenses.


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