Funding Higher Education: More Strategies

The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) changed the name of the Education IRA to the Coverdell Education Savings Account (ESA), and increased the allowable annual contribution amount to $2,000. In addition, these accounts may not be used to pay for elementary and secondary education, as well as college expenses. Income limits may apply. One major advantage of Coverdell ESAs is that if the funds are used to pay for qualified education expenses, e.g., room and board, earnings will not be taxed. Furthermore, you may now contribute to both a Coverdell ESA and a 529 plan for the same beneficiary, without incurring any tax penalties. Be sure to keep in mind that if you do contribute to both, you will need to add these gifts together to determine your gift tax filings.

Provisions to both 529 plans and Coverdell ESAs resulting from EGTRRA are scheduled to sunset on December 31, 2010, unless Congress takes further legislative action.

Education Credits

EGTRRA also provided a boost to the Hope Scholarship Credit and the Lifetime Learning Credit. Income eligibly limits rose, and are now subject to annual inflation adjustments. For 2004, eligibility phases out for married couples filing jointly with adjusted gross incomes (AGIs) of $85,000 ($42,000) for single filers). In addition, the Hope Credit, which provided a $1,500 tax credit for college education expenses during a student’s first two years, will also be eligible for yearly inflation adjustments. The Lifetime Learning Credit, which applies not only to undergraduate study, but also to graduate and professional education pursuits, covers 20% of the first $10,000 in expenses.

College Tuition Deduction

For those whose income exceed the Hope Scholarship and Lifetime Learning Credit limits, an above-the-line deduction applies to qualified higher education costs through 2005. The deduction sunsets after 2005 (unless Congress acts to extend it). The deduction is a dollar-for-dollar amount, up to a maximum, and can be claimed only by those with AGIs below a certain amount as follows:

 Year  Deduction Limit  AGI Limit For Singles AGI Limit On A Joint Return
 2004-2005  $4,000  Not Over $65,000  Not Over $130,000
 2004-2005  $2,00  Not Over $80,000  Not Over $160,000
 2006 and beyond  No Deduction

*Note The deduction is not subject to a phase-out for in-come over the AGI limits. Even one dollar of excess AGI means that no deduction can be claimed.

-Robert Catalano