Tax breaks help lighten college costs
By Pat Curry• Bankrate.com

There's no way around it -- a college education is a pricey proposition. The College Board estimates that by the time the freshman class of 2000 gets a bachelor's degree from the average public college, someone (most likely Mom and Dad) will have spent $45,245 on tuition, room, board, books and supplies.

With all that money going out the door, it's nice to know that what stays behind may be eligible for some tax relief. Whether you're sending your money to college or spending it there yourself, there are a range of tax breaks to consider as you plan your financing strategy.

"The best advice I give people is to assume you'll have to pay something," says Trent Anderson, vice president of Kaplan Inc., publishers of such handy guides as You Can Afford College: The Family Guide to Meeting College Costs. "You either pay in advance, pay as you go or pay later."

Some parents make the mistake of thinking that if they don't save, their child will be in a better position for financial aid, Anderson says. Or, if they do save, they think putting it in their child's name will save them on taxes because their children's income is taxed at a lower rate.

That could backfire, he says, because colleges follow strict guidelines on family contributions before students can be considered for financial aid. Federal guidelines say students must contribute 35 percent of their total assets toward college costs before they're considered for need-based financial aid. Parents only have to contribute 5.7 percent of their assets before eligibility kicks in.

Let's say you save $10,000. If it were in your child's name, he would have to spend $3,500 toward college costs before he's considered for financial aid. If it's in your name, you only have to spend $570.

Tax-free is best
The best tax break out there, one expert says, is to go to school, get your employer to pay for it and let him take the write-off.

"It's a tax-free employee fringe benefit," says Dr. Bill Raabe, a professor of accounting at Samford University in Birmingham, Ala., and the author of several taxation textbooks. "Essentially, it's all someone else's money. You may have to front the money and get reimbursed. Or sometimes they give you the money, have you sign a note and say, 'We'll forgive a third every year.' That's the real plum."

Don't think it's just for people who work for generous companies, either. Individuals who work for themselves can incorporate and give themselves the benefit. That way, they go to school with their corporation paying and take the tax write-off on the corporate return. They can also hire their family members and offer the benefit to them.

Currently, the law says the money can only be used on undergraduate courses, up to $5,250 per year for tuition, fees, books and supplies. "Even at a private school, that's two courses," Raabe notes.

The regulations can change, he says, as Congress looks at the budget and sees what it can afford to subsidize. Right now, it's limited to undergraduate courses, but at other times, it has included graduate programs.

Tax credits
In 1997, Congress passed two education tax credits, the Hope Scholarship Credit and the Lifetime Learning Credit. (For Georgia residents, the credit shouldn't be confused with the lottery-funded HOPE Scholarship.)

"All you have to do is fill out the form to get it," Raabe says. "It's a matter of being up on the provisions."

For the Hope Scholarship Credit, the credit is 100 percent on the first $1,000 of tuition and fees and 50 percent on the next thousand, for the first two years of college.

"The policy behind it is, essentially, free junior college for everybody," Raabe says. "You don't have to be 19; you could be retraining later on in your career."

The Lifetime Learning Credit covers "anything the Hope Scholarship doesn't cover," he says. "You could be in your junior year, or age 65 when you decide to go back to graduate school." That credit is 20 percent of your tuition, up to a $1,000 credit. More flexible than the Hope credit, it's for an unlimited number of tax years and can be taken even if you're only enrolled in a single course, whether it's undergraduate, graduate, professional, technical or continuing education.

The drawback to the credits is that they phase out as your income increases. On a joint return, the phase-out is completed at about $80,000.

State savings plans
Additional tax savings may be available by using a state savings plan. See the College Savings Plan Network or Savingforcollege.com for more infromation. Look at your own state's plan first because it often comes with tax breaks. In New York, money invested in the state savings plan is excluded from state taxes, and the funds can be used at any school in the country. But state plans can vary dramatically in terms of how much money can be invested and the fees. For instance, Iowa's plan limits investments to $2,500 a year; in New York, it's unlimited.

IRAs
An education IRA isn't really an IRA at all -- it's a separate, tax-deferred account -- and it's very limited, but it could be helpful as part of an overall tax strategy, says Cray Anderson, a CPA and partner in the firm of Mintz Rosenfeld and Co. in Fairfield, N.J.

You can only deposit $500 per year per child, and the money deposited can't be deducted on your taxes. However, when you take the money out, you can use it tax-free and there are no penalties for early withdrawal when the money is used for education -- as long as the amount withdrawn is less than what's needed to pay tuition. The income phase-out level is $150,000 on a joint return.

"It earns money tax-free as you go along," Cray Anderson says, "but it's hard to imagine $500 a year, even if you started with a child 1 year old, how you could accumulate very much."

A better deal might be using your real individual retirement account. Distributions can be taken from IRAs without penalties or paying taxes if they're used for education for yourself, your spouse or children, or the grandchildren of you or your spouse.

Anderson notes that planning for college should never interfere with saving for retirement -- and with good reason. Schools can't consider your retirement savings on financial aid forms. So you can save for retirement, reduce your current taxes, and boost your child's eligibility for needs-based loans and grants all at the same time.

Savings Bonds
Another option that makes more sense than the education IRA, Raabe says, is to buy U.S. Savings Bonds. Purchased in the parents' names, they're not taxable at purchase and when you cash them in for education, the earnings are tax-free.

"You've got a better chance to accumulate something serious with Savings Bonds than with the Education IRA," Raabe says. "They have a stable rate of return; that's a real attraction."

The only drawback is record keeping, which is simply keeping track of when they were cashed in and an accounting that the money was spent on tuition and fees.

Cray Anderson says Savings Bonds are an iffy proposition.

"You have to look at the rate of return," he says. "I can invest something at a rate of 10 percent, take the tax hit and come away with 7 percent and still do better than a Savings Bond."

Another option, Cray Anderson says, is zero-coupon bonds. With a typical 10-year maturation, the tax-free bonds can be purchased to have them reach maturity when a child enters college.

If you know you're going to have to borrow to pay for college, consider a home equity loan because mortgage interest on your primary residence is always deductible, and doesn't phase out at higher income levels. Paying down the principal may be worth thinking about as a savings plan if you think your child will go to a public university because equity in a residence is another category that's not counted for financial aid purposes at public schools. Private schools can consider that as an asset.

Tax deductions
The least attractive option, Raabe says, is an itemized tax deduction.

"It's all your money, and it's only a deduction," he explains. "You only get the tax rate times the expenditure."

And then there's the floor to consider. You can't take the deduction if the amount is less than 2 percent of your adjusted gross income. It's also only available for working adults who are taking continuing education to better themselves in their current careers, so it covers tuition, fees, books, travel and transportation. But you can't use it to obtain skills for a new career, or to simply improve your level of education.

"Most people lose it on the floor," Raabe says. "This is why having a tax code that doesn't ever sunset works against us. It was put in in the Reagan/Bush deficit years to increase your taxes without decreasing the deduction. You would think that in times of overwhelming surplus, it would unwind."

Pat Curry is a free-lance writer based in Georgia

-- Posted Oct. 30, 2000