Education Tax Planning for the Upcoming Academic Year

With students heading back to school in the next few weeks, now is a great time to think about education tax planning. We’ve recapped various options to think about:

 

529 Plan distributions – Learn about qualified and non-qualified education costs 

They’re an incredibly popular savings tool for a child’s education fund, but do you know the details with 529 plan distributions?

Only distributions used for qualified education expenses are tax free.  Distributions used for non-qualified education expenses result in income taxes plus a 10% penalty on the earnings portion of the distribution.

Here’s a recap to tell the difference:

Expenses that qualify as an educational expense for 529 plan distributions:

  •  Tuition and fees at post-secondary educational facilities such as colleges and universities, both graduate and undergraduate. Vocational and trade school institutions plus two-year colleges will qualify as well.
  • Student loan payments – subject to a lifetime cap of $10,000.
  • College room and board fees if the student is enrolled at least half-time. Off campus housing and meals will also qualify, capped at the cost of the on-campus room and board fees (based upon the college’s published cost of attendance (COA)).
  • College books and school supplies. Often, this limit is set by the college.
  • Computer and tech expenses that are required for enrollment by the college and required by specific classes. This qualified expense also includes internet expenses incurred by students.
  • Special needs equipment needed by a student to attend a post-secondary institution. Travel expenses, generally not allowed as a 529 plan qualifying expense, often will qualify for special needs students.
  • Tutoring costs.
  • For grades K – 12, 529 plan distributions can also be used for tuition at private schools, capped at $10,000 per year per student.

Expenses that don’t qualify as an educational expense for 529 plan distributions:

  • Premiums paid for student health insurance while attending post-secondary schools, even for a policy offered by the school.
  • Travel costs to and from the qualified school, such as airfare, gas and hotels.
  • Extracurricular activities while attending school.
  • For grades K – 12, home schooling costs do not qualify as an education expense for 529 plan distributions, unless determined by your state that home schooling qualifies as a form of private school.

If your child has opted to study abroad, 529 plan distributions may still qualify to be used for foreign educational expenses:

Several hundred foreign educational institutions qualify to use 529 plan distributions.  Parents and students can check the link provided by the savingforcollege.com website to determine if a student’s foreign (and US) educational institution qualify for the 529 funds to be used for education costs: Federal School Code Lookup for Section 529 Eligible Institutions (savingforcollege.com)

529 Plan distributions to fund ABLE accounts:

Achieving a Better Life Experience (ABLE) accounts are tax advantaged savings accounts set up and funded to benefit children with disabilities.  Distributions from the ABLE account to pay for your child’s qualified disability expenses are exempt from tax.

If your child is diagnosed with a disability and most likely will not be attending a post-secondary institution and you had been funding a 529 plan for your child, you can annually transfer funds from the 529 plan to your child’s ABLE account tax free and penalty free, subject to the annual ABLE contribution funding limit.  Unless extended, this rollover provision expires December 31, 2025.

Special Education costs will qualify as a medical deduction: 

 If your child has a diagnosed medical condition or disability and has been recommended by a physician to attend a special educational institution designed to address your child’s medical condition, the total cost of the education (including lodging and food) will qualify as a medical deduction if the primary reason for attending the institution is to address the medical condition and to assist with your child’s learning disability.  As stated in IRS Publication 502:

“You can include in medical expenses the cost (tuition, meals, and lodging) of attending a school that furnishes special education to help a child to overcome learning disabilities. Overcoming the learning disabilities must be the primary reason for attending the school, and any ordinary education received must be incidental to the special education provided.“

Education tax credits available to taxpayers: 

 Depending on your income, you may qualify for either the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC).

AOTC summarized:

  • The maximum tax credit is $2,500 per student per year.
  • Qualified expenses include tuition and fees; plus books, supplies, and equipment required for enrollment.
  • The first four years of undergraduate education qualify for the AOTC.
  • The student must be enrolled at least half-time in a degree or certificate program.
  • Not available for MFJ filers with income greater than $180K and other filers with income greater than $90K.
  • A portion of the tax credit can be shifted to the student (subject to specific rules) to claim if the parents’ income exceeds the threshold amount noted in item 5 above and the student has income resulting in federal income tax.

LLC summarized:

  • The maximum tax credit is $2,000 per tax return per year.
  • Qualified expenses include tuition and fees; plus books, supplies, and equipment required for enrollment.
  • An unlimited number of years for both undergraduate and graduate education qualify for the LLC.
  • Degree and non-degree programs qualify for the LLC.
  • Not available for MFJ filers with income greater than $180K and other filers with income greater than $90K.
  • A portion of the tax credit can be shifted to the student (subject to specific rules) to claim if the parents’ income exceeds the threshold amount noted in item 5 above and the student has income resulting in federal income tax.

Get A Mid-Year Checkup

Do any of these situations apply to you?

  • You have self-employment income
  • You made a job change during the year
  • You have a change in marital status
  • You have multiple sources of income

If so, then a midyear tax projection is a great tool to avoid any “surprises” on April 15th.

Please contact your tax accountant of one of the MDTAXES CPAs for assistance.

Are You Eligible For Public Service Loan Forgiveness?

Check out the rules available at: Public Service Loan Forgiveness | Federal Student Aid that states

If you are employed by a U.S. federal, state, local, or tribal government or not-for-profit organization, you might be eligible for the Public Service Loan Forgiveness Program. The PSLF Program forgives the remaining balance on your Direct Loans after you have made 120 qualifying monthly payments under a qualifying repayment plan while working full-time for a qualifying employer.

To qualify for PSLF, you must:

Qualifying Employer:

Qualifying employment for the PSLF Program isn’t about the specific job that you do for your employer. Instead, it’s about who your employer is. Employment with the following types of organizations qualifies for PSLF:

  • Government organizations at any level (U.S. federal, state, local, or tribal) – this includes the U.S. military
  • Not-for-profit organizations that are tax-exempt under Section 501(c)(3) of the Internal Revenue Code

Serving as a full-time AmeriCorps or Peace Corps volunteer also counts as qualifying employment for the PSLF Program. Use our employer search tool to help determine if your employer qualifies for PSLF.

More information is available at: https://studentaid.gov/manage-loans/forgiveness-cancellation/public-service or read through these FAQs.

IRS increases mileage rate for remainder of 2022

The IRS recently announced an increase of 4 cents to the optional standard mileage rate due to the increase in gas prices.  The new rates are effective July 1, 2022- December 31, 2022:

  • Business travel rate is now 62.5 cents per mile
  • Deductible medical expenses is now 22 cents per mile
  • Moving expenses (available for active-duty members of the military) is now 22 cents per mile

Note – the 14 cents per mile rate for charitable organizations remains unchanged as it’s set by statute.

You can use the optional rate to calculate the deductible costs of operating a car for business and certain other purposes in lieu of tracking actual costs.  Taxpayers always have the option of calculating the actual costs of using their vehicle rather than using the standard mileage rates.

This rate is also used as a benchmark by the federal government and many businesses to reimburse their employees for mileage.

Midyear increases in the optional mileage rates are rare, the last time the IRS made such an increase was in 2011.

Tips for Your Kids and Their Employment

It’s summertime and we often get asked about how to handle taxes and forms for a child’s summer job or first job out of college. We’re recapping some tips below:

Completing Form W-4 for summer jobs:

When you child begins their summer job, their new employer will require them to complete a Form W-4, Employee’s Withholding Certificate.  The W-4 instructs the employer how to withhold income taxes from your child’s paycheck.  For your kids working over the summer consider claiming “Exempt” from withheld federal income taxes on their paychecks.  The IRS allows a taxpayer to claim an exemption from federal tax withholdings if they had no federal income tax liability in 2021 and they expect to have no federal income tax liability in 2022. Assuming that your child expects to earn only a small amount of pay this year and did not have a tax liability the prior year, your child can write “Exempt” on line 4(c) of the Form W-4 and no federal income taxes will be withheld from their pay – leaving a larger weekly net paycheck for your child.

Completing Form W-4 for recent college grad’s first job:

When you complete the Form W-4, your employer will withhold income taxes based upon the assumption that earnings will be for an entire calendar year.  However, recent college grads beginning full-time employment soon after graduation will only be working a partial calendar year their first working year.  The IRS income tax withholding tables are based upon a full year of earned wages.  For recent college grads working a partial year, most likely more taxes will be withheld than needed from their weekly paycheck, which may result in a large tax refund the following spring when the tax return is prepared.  Instead of waiting until the following spring to receive the refund for the over withheld taxes, employees working a partial year can submit a request in writing to their employer to have less taxes withheld from their weekly paycheck (leaving a larger net take home pay in each paycheck).   This “part-year tax withholding method” statement prepared by the employee and given to their employer should include the following:

  • The last day of your employment in the calendar year,
  • That you use the calendar year for your tax return reporting, and
  • That you will be employed no more than 245 days (from all employers in the calendar year)

Is your child being paid as an independent contractor?

Although most employers pay their summer hires as employees and report the income earned and taxes withheld on a W-2, occasionally a company will pay their summer staff as independent contractors issuing a 1099-NEC to your child at year end.  When working jobs in sales, social media, and freelance, workers are frequently paid as independent contractors.  And although your child’s total income earned for the summer may not require any income tax to be paid, they would be responsible to pay “self-employment” taxes on this income if they are paid more than $400.  How can you determine if the employment is as an independent contractor (1099-NEC) or as an employee (W-2)?  If social security taxes and Medicare taxes are being withheld from pay, then your child is hired as an employee and will receive a W-2 at year end.  However, if no taxes are being withheld, then payment is made as an independent contractor and your child will need to pay self-employment taxes at year end.  Be aware, if independent contractor status, then your child will owe 15.3% of their pay for self-employment taxes even if no income taxes are owed and your child will need to file a tax return at year end to pay this tax.

What about Venmo and PayPal sales?

If your child is selling or re-selling items through the internet and receives a 1099—K from Venmo or PayPal at year end, this would be considered self-employment income as well.  Additionally, be sure to track the costs of your child’s “business expenses” such as costs of “inventory” being sold in your child’s business plus other selling expenses (web hosting, advertising, postage, etc).  These business-related costs are allowed to be deducted from income received.  And taxes to be paid are based upon the Net Income of the business (collections less related business costs).

Take advantage of Roth IRA Contributions!! 

Even if your child has only a small amount of earned income from a summer job, they will still be eligible to contribute to a Roth IRA under their name.  The contribution allowed is limited to the lesser of the child’s earned income and $6,000.  The major benefit of funding a Roth IRA early in your child’s career is that the earnings in the Roth IRA grow tax free over your child’s lifetime.  The Roth IRA contribution can be funded by parents (or grandparents) as a gift to your child and doesn’t need to come directly from your child’s bank account. And remember, the dollars must be funded into a Roth IRA under your child’s name.