The question of “who controls the funds held in a Section 529 qualified tuition account?” is a very common question we hear. To answer this question please read the following:
Some parents will simply save money for their child or children’s college costs in a custodial account; these accounts become the children’s property once they reach the age of majority, depending upon state law, which is usually 18 or 21. At that point, the parents lose control. Unlike these child custodial accounts, Section 529 plans are not irrevocable gifts: The parent or other account owner retains control.
Generally, the same person who contributed the money controls the Section 529 account. This doesn’t have to be the case, however. Someone else, such as a grandparent, could make a donation but name the child’s parent as the account owner, or a parent could establish the account and allow others to contribute to it.
Money cannot be removed from the account without the permission of the account owner. If the child (the designated beneficiary of the plan) decides not to go to school, the account owner can simply change the beneficiary to another “family member,” a term that, for the purposes of beneficiary changes, can refer to the beneficiary’s sons, daughters, brothers, sisters, nephews and nieces, certain in-laws, and any spouse of any of those individuals—but not the spouse of the original beneficiary.
This rule for beneficiary changes gives parents and other donors the flexibility to use the funds for the family member who needs them the most. For example, if a designated beneficiary decides not to attend college or receives a full scholarship, another child can be named (as long as the new child is a member of the family). Alternately, if funds remain in the plan after a child has finished school, a younger family member can be named as the beneficiary for the balance.
There are no tax issues if the transfer is within the same generation or an older generation of the family, such as changing the beneficiary to a sibling of the original beneficiary. However, if the transfer is to a beneficiary in a younger generation, the transfer is considered a taxable gift from the old beneficiary to the new beneficiary, and a gift tax return will need to be filed.
If you have questions related to Section 529 plans and how they might be used to save for a child’s future education, please call Dagley & Co.
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Are you a parent? Did you know there are a significant number of tax benefits available to you? Whether you’re single, divorced or married, there are many deductions, exemptions and credits that can help put a dent in your tax liability.
Exemptions – Regardless of filing status, you receive a $4,050 income exemption for each of your qualifying children whom you claim as a dependent on your tax return. In the case of divorced or separated parents, the exemption is allowed to the custodial parent unless the custodial parent releases the exemption to the non-custodial parent. If you are the custodial parent, you can release the exemption on a year-by-year basis or for multiple years if you wish to do so. However, being unable to foresee the future means it is generally wiser to release the exemption annually. The exemption amount gradually decreases to zero once a certain income threshold is reached; this phase out generally applies to higher income taxpayers.
Child Tax Credit – If you have dependent children, you are also entitled to a nonrefundable tax credit of $1,000 for each child under the age of 17 at the close of the year. The term “nonrefundable” means the credit can only be used to offset any tax liability you may have, and the balance of the credit is lost. If you are not filing jointly with the child’s other parent and have released the exemption to that parent, then you will not qualify for the child tax credit for that child. In addition, this credit also phases out for higher income taxpayers. For lower income parents, a portion of the child tax credit, which is normally nonrefundable, can become refundable.
Earned Income Tax Credit – The earned income credit benefits lower income parents based upon your earned income, filing status (either married filing jointly or unmarried) and the number of qualifying children you have up to three. The credit for 2017 can be as much as $6,318, and better yet, the amount not used to offset your tax liability is fully refundable. This credit is phased out for higher income filers, and those with investment income of more than $3,450 for 2017 aren’t eligible.
Head of Household Filing Status – The tax code provides a special filing status – head of household – for unmarried and separated taxpayers. The benefit of head of household filing status is that it provides lower tax rates and a higher standard deduction than the single status ($9,350 as opposed to $6,350 for a single individual in 2017). If you are an unmarried parent and you pay more than one-half the cost of the household for yourself and your child, you qualify for this filing status. Even if you are married, if you lived apart from your spouse the last six months of the year and pay more than one-half the cost of the household for yourself and your child, you qualify for this filing status.
Childcare – Many parents who work or are looking for work must arrange for care of their children. If this is your situation, and your children requiring care are under 13 years of age, you may qualify for a nonrefundable tax credit that can reduce your federal income taxes.
The childcare credit is an income-based percentage of up to $3,000 of qualifying care expenses for one child and up to $6,000 of qualifying care expenses for two or more children. The allowable expenses are also limited to your earned income, and if you are married, both you and your spouse must work and the limit is based upon the earned income of the spouse with the lower earnings. The credit percentages range from a maximum of 35% if your adjusted gross income (AGI) is $15,000 or less to 20% for an AGI of over $43,000.
If your employer provides dependent care benefits under a qualified plan that pays your child care provider either directly or by reimbursing you for the expenses, or your employer provides a day care facility, you may be able to exclude these benefits from your income. Of course, the same expenses aren’t eligible for both tax-free income and the child care credit.
Education Savings Plans – The tax code provides two plans to save for your children’s future education. The first is the Coverdell Education Savings Account, which allows non-deductible contributions of up to $2,000 per year. The earnings on these accounts are tax-free provided the amounts withdrawn from the accounts are used to pay qualified expenses for kindergarten and above. Coverdell contributions will phase out for higher income taxpayers beginning at an AGI of $190,000 for married taxpayers filing jointly and half that amount for other taxpayers.
A second plan, called a Qualified Tuition Plan (sometimes referred to as a Sec 529 plan), allows individuals to gift large sums of money for a family member’s college education while continuing to maintain control of the funds. The earnings from these accounts grow tax-deferred and are tax-free if used to pay for college tuition and related expenses.
Contributions to these plans are not limited to the child’s parents and can be made by virtually anyone, although if not the parents, then typically it is the grandparents who fund the accounts.
Education Credits – If you are a parent with a child or children in college, don’t overlook the American Opportunity Tax Credit (AOTC). It provides a tax credit equal to 100% of the first $2,000 of qualified tuition and related expenses and 25% of the next $2,000 for each child who was enrolled at least half time. Better yet, 40% of the credit is refundable. This credit is good for the first four years of post-secondary education.
There is a second education credit called the Lifetime Learning Credit (LLC) that provides a nonrefundable tax credit equal to 20% of up to $10,000 of qualified tuition and related expenses. Unlike the AOTC, which is allowed per student, the LLC is calculated on a per-family basis with a maximum credit of $2,000 but is not limited to the first four years of post-secondary education.
You don’t even have to pay the expenses to get the credits. The credits are allowed to the person claiming the exemption for the child. So if the child’s grandparent, uncle, aunt or even an ex-spouse or the child’s other parent pays the tuition, you still get the credit as long you claim the child as your dependent.
Student Loan Interest – Generally, personal interest you pay, other than certain mortgage interest, isn’t deductible on your tax return. However, there is a special deduction, up to $2,500 per year, allowed for interest paid on a student loan (also known as an education loan) used for higher education. You don’t have to itemize deductions to take advantage of this deduction, but you must have paid the interest on a loan taken out for your own or your spouse’s education or that of a dependent. So if you were legally obligated to pay the loan for one of your children who was your dependent when the loan was taken out, you may be able to claim this deduction, even if the child is no longer your dependent.
The student must have been enrolled at least half-time, and the loan must have been taken out solely to pay qualified higher education expenses. The lender can’t be a related person. This deduction phases out if your AGI is more than $65,000 ($130,000 if filing a joint return) and isn’t allowed if you use the married filing separate status.
Child’s Medical Expenses – If you itemize deductions, the unreimbursed medical expenses you pay for your dependents are counted for figuring your total medical expenses. This is true for both parents even if they do not file together as long as one of them is able to claim the child as a dependent.
If you have questions related to any of these benefits, please give Dagley & Co. a call.
Summer is unfortunately coming to an end, and with that means back to school for many young adults. What this also means is time for their parents or family members to dig into their pockets to help pay for that schooling.
Paying for education can be financially challenging for many families. However, tuition and related expenses paid for higher education can qualify for one of two tax credits, which will lower the income tax burden for the individual who claims the exemption for the student. For example, if the student were claimed as a dependent on the parents’ return, the parents would claim the credit, but if the student filed independently, he or she would get the credit. This is true regardless of who actually pays the tuition and related expenses.
American Opportunity Tax Credit (AOTC) – The AOTC provides a credit of up to $2,500 per year per eligible student. Generally, tax credits are non-refundable, meaning they can only be used to offset any tax liability the taxpayer may have for the year. However, up to 40% of the AOTC is refundable, even when the taxpayer has no tax liability. Thus, it can result in a refund of as much as $1,000 (40% of $2,500).
The credit is for 100% of the first $2,000 of tuition and related expenses and 25% of the next $2,000 of qualifying expenses. However, the AOTC is only allowed for four years of post-secondary education. It is also determined on a per student basis and phases out for higher-income taxpayers. The student must be enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential for at least one academic period beginning in the tax year of the credit.
Lifetime Learning Credit (LLC) ‒ The LLC is a non-refundable credit worth up to $2,000 per year, and there is no limit on the number of years that the LLC can be claimed. Unlike the AOTC, there is no “half-time student” requirement, and single courses can qualify. The credit is 20% of the cost of tuition and related expenses. However, while the AOTC is determined on a per student basis, the LLC is based upon the tax family’s qualified education expenses for the year. Where a student qualifies for the more beneficial AOTC, that student’s expenses cannot be used for the LLC.
There are additional requirements that apply to both credits:
- Qualified expenses ‒ Qualified expenses include the costs you pay for tuition, fees, and other related expenses for an eligible student to enroll at or attend an eligible educational institution.
- Eligible educational institutions ‒ Eligible institutions generally include any accredited public, nonprofit, or proprietary post-secondary institution eligible to participate in the student aid programs administered by the Department of Education. This includes most colleges and universities. Vocational schools or other post-secondary schools may also qualify. If you aren’t sure if the student’s school is eligible, ask the school if it is an eligible educational institution.
- Form 1098-T ‒ In most cases, you (or the student) should receive Form 1098-T, Tuition Statement, from the school reporting the qualifying expenses to the IRS and to you. The amount shown on the form may be either (1) the amount you paid to the school for qualifying tuition and related expenses, or (2) the amount billed by the school for qualifying tuition and related expenses. Therefore, the amount shown on the form may be different from the amount eligible for the credit. Don’t forget that you can only claim an education credit for the qualifying tuition and related expenses that you paid in the tax year and not just the amount the school billed. There is a provision that allows the tuition for the first three months of the next year to be prepaid and deducted on the tax return for the year of payment. However, prepaid tuition cannot be deducted in the subsequent year.
There are other education tax benefits available as well, such as the education loan interest deduction and savings bond interest exclusion. If you are reading this article so you can plan for the future, there are also tax-advantage education savings plans available – the Coverdell and Sec 529 plans.
Interested in how the education credits or other tax benefits might apply to you? Give Dagley & Co., CPA a call at (202) 417-6640.
When it comes to saving for your children’s education, the tax code provides two primary advantages. We frequently get questions about the differences between the programs and about which program is best suited for a family’s particular needs.
The Coverdell Education Savings Account and the Qualified Tuition Plan (frequently referred to as a Sec 529 Plan) are similar; neither provides tax-deductible contributions, but both plans’ earnings are tax-free if used for allowable expenses, such as tuition. Therefore, with either plan, the greatest benefit is derived by making contributions to the plan as soon as possible—even the day after a child is born—so as to accumulate years of investment earnings and maximize the benefits. However, that is where the similarities end, and each plan has a different set of rules.
Coverdell Savings Accounts only allow a total annual maximum contribution of $2,000. The contributions can be made by anyone, including the beneficiary, so long as the contributor’s adjusted gross income is not high enough to phase out the allowable contribution. (The phase-out threshold is $190,000 for married contributors filing jointly and $95,000 for others.) Unless the beneficiary of the account is a special needs student, the funds must be withdrawn prior to age 30. The funds can be used for kindergarten through post-secondary education. Allowable expenses generally include tuition; room, board, and travel expenses required to attend school; books; and other supplies. Tutoring for special needs students is also allowed. Funds can be rolled over from one beneficiary to another in the same family. Although the funds can be used starting in kindergarten, the chances are that not enough of earnings will have been accumulated by that time to provide any significant benefit.
On the other hand, state-run Sec 529 plan benefits are limited to postsecondary education, but they allow significantly larger amounts to be contributed; multiple people can each contribute up to the gift tax limit each year. This limit is $14,000 for 2015, and it is periodically adjusted for inflation. A special rule allows contributors to make up to five years of contribution in advance (for a total of $70,000 in 2015).
Sec. 529 Plans allow taxpayers to put away larger amounts of money, limited only by the contributor’s gift tax concerns and the contribution limits of the intended plan. There are no limits on the number of contributors, and there are no income or age limitations. The maximum amount that can be contributed per beneficiary is based on the projected cost of college education and will vary between the states’ plans. Some states base their maximum on an in-state four-year education, but others use the cost of the most expensive schools in the U.S., including graduate studies. Most have limits in excess of $200,000, with some topping $370,000. Generally, once an account reaches that level, additional contributions cannot be made, but that doesn’t prevent the account from continuing to grow.
Which plan (or combination of plans) is best for your family depends on a number of issues, including education goals, the number and ages of your children, the finances of your family and of any grandparents or other relatives willing to help, and a number of other issues. For assistance in establishing education savings plans, please get in touch with us at Dagley & Co.
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If you’re smart enough to seek an advanced education (and/or help your children seek it for themselves), be smart enough to take advantage of its tax breaks! Going to college – and figuring out how to pay for it – can be stressful for students and their families. Congress has provided a variety of new tax incentives to help defray the cost of education. Some of these require long-term planning to become beneficial, while others provide almost immediate tax deductions or credits. The benefits may even cover vocational schools.
If your child is below college age, there are tax-advantaged plans that allow you to save for the cost of college. Although providing no tax benefit for contributions to the plans, they do provide tax-free accumulation; so the earlier they are established, the more you benefit from them.
- Section 529 Plans—Section 529 Plans (named after the section of the IRS Code that created them) are plans established to help families save and pay for college in a tax-advantaged way and are available to everyone, regardless of income. These state-sponsored plans allow you to gift large sums of money for a family member’s college education while maintaining control of the funds. The earnings from these accounts grow tax-deferred and are tax-free, if used to pay for qualified higher education expenses. They can be used as an estate-planning tool as well, providing a means to transfer large amounts of money without gift tax. With all these tax benefits, 529 Plans are an excellent vehicle for college funding. Section 529 Plans come in two types, allowing you to either save funds in a tax-free account to be used later for higher education costs, or to prepay tuition for qualified universities. For 2015, you can contribute $14,000 without gift tax implications (or $28,000 for married couples who agree to split their gift). The annual amount is subject to inflation-adjustment. There is also a special gift provision allowing the donor to prepay five years of Sec 529 gifts up front without gift tax.
- Coverdell Education Savings Account—These accounts are actually education trusts that allow nondeductible contributions to be invested for a child’s education. Tax on earnings from these accounts is deferred until the funds are withdrawn, and if used for qualified education purposes, the entire withdrawal can be tax-free. Qualified use of these funds includes elementary and secondary education expenses in addition to post-secondary schools (colleges). This is the only one of the educational tax benefits that allows tax-free use of the funds for below college-level expenses. A total of $2,000 per year can be contributed for each beneficiary under the age of 18. The ability to contribute to these plans phases out when the modified adjusted gross income is between $190,000 and $220,000 for married taxpayers filing jointly, and between $95,000 and $110,000 for all others.
- Education Tax Credits—Two tax credits, the American Opportunity Credit (partially refundable) and the Lifetime Learning Credit (nonrefundable), are available for qualified post-secondary education expenses for a taxpayer, spouse, and eligible dependents. Both credits will reduce one’s tax liability dollar for dollar until the tax reaches zero. The credit is not allowed for taxpayers who file Married Separate returns.
- The American Opportunity Credit—is a credit of up to $2,500 per student per year, covering the first four years of qualified post-secondary education. The credit is 100% of the first $2,000 of qualifying expenses plus 25% of the next $2,000 for a student attending college on at least a half-time basis. Forty percent of the American Opportunity credit is refundable (if the tax liability is reduced to zero). This credit phases out for joint filing taxpayers with modified adjusted gross income between $160,000 and $180,000, and between $80,000 and $90,000 for others.
- The Lifetime Learning Credit—is a credit of up to 20% of the first $10,000 of qualifying higher education expenses. Unlike the American Opportunity Credit, which is on a per-student basis, this credit is per taxpayer. In addition to post-secondary education, the Lifetime Credit applies to any course of instruction at an eligible institution taken to acquire or improve job skills. For 2015 this credit phases out for joint filing taxpayers with modified adjusted gross income between $110,000 and $130,000, and between $55,000 and $65,000 for others. The credit is not allowed for taxpayers who file Married Separate returns.
Qualifying expenses for these credits are generally limited to tuition. However, student activity fees and fees for course-related books, supplies, and equipment qualify if they must be paid directly to the educational institution for the enrollment or attendance of the student.
You may qualify for this credit even if you did not pay the tuition. If a third party (someone other than the taxpayer or a claimed dependent) makes a payment directly to an eligible educational institution for a student’s qualified tuition and related expenses, the student would be treated as having received the payment from the third party, and, in turn, pay the qualified tuition and related expenses. Furthermore, qualified tuition and related expenses paid by a student would be treated as paid by the taxpayer if the student is a claimed dependent of the taxpayer.
- Education Loan Interest—You can deduct qualified interest of $2,500 per year in computing AGI. This is not limited to government student loans and this could include home equity loans, credit card debt, etc., if the debt was incurred solely to pay for qualified higher education expenses. For 2015, this deduction phases out for married taxpayers with an AGI between $130,000 and $160,000 and for unmarried taxpayers between $65,000 and $80,000. This deduction is not allowed for taxpayers who file married separate returns.
We all know that a child’s success in life has a great deal to do with the education they receive. You cannot start the planning process too early. Please call Dagley & Co. if you would like assistance in planning for your children’s future education.
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Education is an investment in the self, and it comes with a few tax breaks. The tax code includes a number of incentives that, with proper planning, can provide tax benefits. Which of these options will provide the greatest tax benefit depends on each individual’s particular circumstances. The following is an overview of the various possibilities that should be taken advantage of should you qualify:
Student Loans – How to pay for college is a major planning issue for most seeking advanced education. Those with substantial savings simply pay the expenses as they go while others begin setting aside money far in advance of the education need, perhaps utilizing a Coverdell account or Sec. 529 plan. Others will need to borrow the funds, obtain financial aid, or be lucky enough to qualify for a scholarship. Although student loans provide one ready source of financing, the interest rates are generally higher than a home equity debt loan, which can also provide a longer repayment term and lower payments.
When choosing between a home equity loan or student loan, keep in mind the following limitations: (1) Interest on home equity debt is deductible only if you itemize, and then only on the first $100,000 of debt, and not at all to the extent that you are taxed by the alternative minimum tax; and (2) student loans must be single-purpose loans—the interest deduction is available even if you do not itemize but is limited to $2,500 per year, and the deduction phases out for joint filers with income (AGI) between $130,000 and $160,000 ($65,000 to $80,000 for unmarried taxpayers).
Gifting Low Basis Assets – Another frequently used tax strategy to finance education is to gift appreciated assets (typically stock) to a child and then allow the child to sell the stock to pay for the education. This results in transferring any gain on the stock to the child at a time when the child has little or no other income; tax on the gain is avoided or is at the child’s low rate. With the lowest of the long-term capital gains rates currently being zero, Congress curtailed income shifting to children by making most full-time students under the age of 24 subject to the “kiddie tax.” This effectively taxes their unearned income at their parents’ tax rates and makes the gifting of appreciated assets to a child less appealing as a way to finance college expenses.
Education Credits – The tax code provides tax credits for post-secondary education tuition paid during the year for the taxpayer and dependents. Currently, there are two types of credits: the American Opportunity Credit, which is limited to any four tax years for the first four years of post-secondary education and provides up to $2,500 of credit for each student (some of which may be refundable), and the Lifetime Learning Credit, which provides up to $2,000 of credit for each family each year. The American Opportunity Credit is phased out for joint filers with incomes between $160,000 and $180,000 ($80,000 to $90,000 for single filers). The 2015 phaseout ranges for the Lifetime Learning Credit are $110,000–$130,000 for married joint and $55,000–$65,000 for others. Neither credit is allowed for married individuals who file separately. Careful planning for the timing of tuition payments can provide substantial tax benefits.
Education Savings Programs – For those who wish to establish a formalized long-term savings program to educate their children, the tax code provides two plans. The first is a Coverdell Education Savings Account, which allows the taxpayer to make $2,000 annual nondeductible contributions to the plan. The second plan is the Qualified Tuition Plan, more frequently referred to as a Sec. 529 plan, with annual nondeductible contributions generally limited to the gift tax exemption for the year ($14,000 in 2015). Both plans provide tax-free earnings if used for qualified education expenses. When choosing between a Coverdell or Sec. 529 plan, keep the following in mind: (1) Coverdell accounts can be used for kindergarten through post-secondary education and become the property of the child at age of majority, and contributions are phased out for joint filers between $190,000 and $220,000 ($95,000 and $110,000 for others) of income (AGI); and (2) Sec. 529 plans are only for post-secondary education, but the contributor retains control of the funds and there is no phase out of the contribution based on income.
Educational Savings Bond Interest—There is also an exclusion of savings bond interest for Series EE or I Bonds that were issued after 1989 and purchased by an individual over the age of 24. All or part of the interest on these bonds is exempt from tax if qualified higher education expenses are paid in the same year that the bonds are redeemed. As with other benefits, this one also has a phase-out limitation for joint filers with income between $115,750 and $145,750 ($77,200 and $92,200 for unmarried taxpayers, but those using the married filing separately status do not qualify for the exclusion). The exclusion is computed on IRS Form 8815, Exclusion of Interest from Series EE and I U.S. Savings Bonds Issued After 1989.
If you would like to learn more about these benefits, or to work out a comprehensive plan to take advantage of them, please get in touch with us at Dagley & Co. for assistance.
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