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Take Advantage of Tax Provisions Available for College Costs

To help pay for expenses, many parents and grandparents saved money in tax favored accounts, such as 529 plans.  Once your child or grandchild has been accepted and is attending, there are several tax provisions available to assist in paying the costs.

Tuition Tax Credits

The American Opportunity Tax Credit (AOTC) is available for the first four years of college.  It is up to $2,500 per student and is partially refundable.  This means the credit is not lost if the credit amount is greater than your tax liability. The maximum refundable credit for AOTC is $1,000.  Expenses covered by the credit are tuition, fees, and books.  All the first $2,000 of costs are covered, and 25% of the next $2,000.

The Lifetime Learning Credit is available for additional years of college classwork.  This credit is 20% of covered expenses, up to $2,000 per family.

Both credits are subject to income limits and begin to be phased out at $160,000 for married couples and $80,000 for single taxpayers.  Each year, only one credit can be claimed per student. For example, with two kids in school, you could claim AOTC for each child, or you may claim the AOTC for one student and the Lifetime Credit for the other child.

Scholarships may be tax exempt

Scholarships can be exempt from tax.  The scholarship can’t be compensation for services; it must be for tuition, fees, books, and supplies.  A student can have a tax-exempt scholarship and still qualify for one of the above credits in the same year, but the expenses available for the credit need to be reduced by the amount of the scholarship.

Payments by others to assist with costs

Money received from others to help pay for your child’s expenses is generally a gift.  Amounts under the per recipient annual exclusion are not subject to gift tax.  For 2023, the exclusion is $17,000 per recipient.  If the payment for tuition is made directly to the educational institution, the normal gift tax limit does not apply.  It is important to remember that the ‘unlimited gifting” of tuition only is available for “tuition” payments made directly to the university/college.   Any payments for room and board, books, or other college fees/expenses would go against the payer’s annual $17,000 gift exclusion amount.

Retirement account withdrawals are not subject to an early withdrawal penalty

Withdrawals from a traditional or Roth IRA to pay for college costs are not subject to the normal early withdrawal penalty.  The distributions would still be subject to income tax under the normal rules for traditional and Roth IRAs.

Planning considerations

Some states offer additional credits or deductions to assist with tuition.  Wisconsin offers a subtraction from taxable income for tuition payments to WI state colleges as well as payments made to fund the WI 529 education savings program, EDVEST.  The eligible expenses for the different credits and state programs are not always the same.

Please contact your tax professional at Wegner CPAs to assist with maximizing the available college tax benefits.

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