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.