Education Tax Breaks

Tax breaks to help you pay educational expenses are some of the most commonly overlooked federal tax breaks. They shouldn’t be. These are very valuable tax breaks and we can help you maximize your tax savings.
Getting the most from the education tax incentives requires careful planning, particularly because of the interrelationship between many of the rules. Although the IRS provides guidance, some of the IRS’ explanations have actually complicated matters in some circumstances.
Let’s take a look at some of the education tax incentives:
American Opportunity Tax Credit. The American Opportunity Tax Credit (AOTC) provides a maximum credit amount of $2,500 per year for four years of post-secondary education The AOTC is computed as 100 percent of up to $2,000 qualified higher education expenses plus 25 percent of the next $2,000 of eligible expenses. The AOTC begins to “phase out” for married couples filing jointly with adjusted gross income (AGI) between $160,000 and $180,000. The AOTC begins to phase out for single individuals with AGI between $80,000 and $90,000. Forty percent of the AOTC is refundable for those lower-income taxpayers with a tax liability smaller than the credit amount.
To qualify for the AOTC, the tuition must be paid on behalf of the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent. An eligible student for purposes of the credit is an individual who is enrolled in a degree, certificate or other program leading to a recognized educational credential at an eligible educational institution. The student must be enrolled at least half-time and must not have been convicted of a federal or state felony for possession or distribution of a controlled substance. Study at many types of post-secondary institutions qualifies for the credit, such as programs for a bachelor’s degree, associate’s degree or another recognized post-secondary credential.
Lifetime Learning credit. The Lifetime Learning credit can be claimed for an unlimited number of tax years. The Lifetime Learning credit equals 20 percent of up to $10,000 in eligible education costs during the tax year. The Lifetime Learning credit is subject to phase-out rules based on adjusted gross income.
The Lifetime Learning credit may be applied to a non-degree program. For example, an individual who is enrolled in a non-degree program to improve job skills may be eligible for the credit. Moreover, the Lifetime Learning credit may be claimed even if the student is not enrolled at least half-time. An individual who is taking just one class at a community college, for example, may be eligible for the credit.
Higher education deduction. Eligible taxpayers can claim an above-the-line deduction for qualified tuition and related expenses. Eligible expenses include those spent on behalf of the taxpayer, his or her spouse or dependents at a post-secondary institution. The college or school must be eligible to participate in the federal student loan program. The amount of the deduction depends on your AGI.
As an above-the-line deduction, the deduction for qualified tuition and related expenses could be taken even if the taxpayer does not itemize deductions, and it is not subject to the two-percent floor.
Unless this tax benefit is extended again, it is not available after 2016.
Section 529 plans. The Tax Code allows states and some educational institutions to offer “529” plans (known for the section of the Tax Code that governs them). They are also sometimes called qualified tuition programs (QTPs). They allow you to either prepay or contribute to an account for paying a student’s post-secondary education expenses. An eligible educational institution generally includes colleges, universities, vocational schools or other post-secondary educational institutions. In addition, distributions from state programs, even to the extent of earnings, are now entirely tax-free to the extent used for qualified higher education expenses.
Qualified higher education expenses include tuition, fees, books, supplies, and equipment required for the beneficiary’s enrollment at an eligible educational institution, which includes most institutions that participate in federal student aid programs. The cost of computers or peripheral equipment, computer software, and internet access and related services also qualify as higher education expenses. If the student is attending an institution at least half-time, room and board is treated as a qualified expense.
Coverdell education savings accounts. Coverdell education savings accounts (also sometimes called education IRAs) are similar to IRAs. You can save today for future educational expenses and not just higher educational expenses. Funds in a Coverdell ESA can also be used for K-12 and related expenses. The American Taxpayer Relief Act made permanent some temporary enhancements to Coverdell ESAs.  The maximum annual Coverdell ESA contribution is $2,000 per beneficiary. Contributions are not deductible by the donor and are not included in the beneficiary’s income as long as they are used to pay for qualified education expenses.
Contributions generally must stop when the beneficiary turns age 18 except for individuals with special needs. Parents can maximize benefits, however, by transferring older siblings’ accounts for use by a younger brother, sister or first cousin, thereby maximizing the tax-free growth period. Excess contributions are subject to an excise tax.
The phase-out amounts of adjusted gross income allowed for a contributor to a Coverdell ESA are generous. The annual contribution starts to phase out for married couples filing jointly with modified AGI at or above $190,000 and less than $220,000 and at or above $95,000 and less than $110,000 for single individuals.
Many individuals find Coverdell education savings accounts attractive because distributions can be used for room and board (if the designated beneficiary is enrolled at least half-time) as well as for qualified tuition and the costs of books and supplies required for enrollment. Beneficiaries who have special needs may also find these expenses qualify.
Education savings bond interest exclusion. When you use U.S. savings bonds to pay qualified higher education expenses, the interest may be excluded from income if your income is below a certain range. Qualified education expenses include the cost of tuition and fees at an eligible educational institution for the taxpayer, the taxpayer’s spouse or the taxpayer’s dependent at an eligible educational institution. Colleges, universities and vocational schools that participate in federal student aid programs generally qualify for the incentive.
For bond interest to be excluded, the taxpayer must have attained the age of 24 before the issue date of the bonds. Qualified bonds must also be issued in the name of the taxpayer as sole owner or in the name of the taxpayer and the taxpayer’s spouse as co-owners. Married taxpayers must file a joint return to exclude bond interest.
Employer-provided educational assistance exclusion. When an employer pays an employee’s education expenses, the tax consequences depend on the reason for the education. Your employer may have a plan under which it pays for qualified education expenses for college or graduate studies. If it has such a plan, up to $5,250 of education benefits can excluded from the recipient’s gross income each year. Employer-provided educational assistance can include tuition, fees, books, supplies and equipment.
Job-related educational expenses. If you are taking a course because it is directly related to improving your job performance and your employer does not cover it, you may be able to deduct it as a miscellaneous itemized deduction if you itemized deductions. Under this deduction, tuition, course materials, and even the cost of transportation to and from class may be deductible. There are some restrictions, however: miscellaneous deductions are deductible only in excess of two percent of your adjusted gross income; and any degree program that qualifies you for a “new trade or business” cannot be deducted under this provision no matter how helpful it also may be to your present job.
Deduction for interest on education loans. Student loan interest of up to $2,500 a year is deductible whether or not you itemize your deductions. The deduction is completely phased when a taxpayer’s modified AGI exceeds certain thresholds. Only those legally obligated to make the loan payments may deduct them. Individuals who are claimed as dependents on another person’s return cannot take this deduction. Qualified educational institutions for the student loan interest deduction are generally ones that participate in federal student aid programs.
IRAs. The Tax Code also allows individuals under age 59 1/2 to take distributions from an IRA for qualified higher education expenses without having to pay the 10 percent early withdrawal penalty. The qualified education expenses generally must be for the IRA holder, his or her spouse, or a child (including a foster child). Qualified education expenses include tuition, books and supplies. Room and board is also a qualified expense if the individual is at least a half-time student. An eligible education institution is generally one that participates in federal student aid programs.
Coordination. As you have read, there are many federal education tax incentives. All of the incentives must be coordinated; that is, you may not be able to take everyone. You generally cannot use education expenses to claim a double benefit. Many taxpayers make genuine and honest mistakes when trying to coordinate the education incentives without help from a tax professional. These mistakes are very costly. If you are considering claiming any of the education incentives, please contact our office.

IRS provides relief to all affected by the Boston tragedy

The IRS has announced a three-month filing and payment extension for taxpayers and others affected by the events in Boston on Monday. According to the IRS, This relief applies to all individual taxpayers who live in Suffolk County, Mass., including the city of Boston. It also includes victims, their families, first responders, others impacted by this tragedy who live outside Suffolk County, and taxpayers whose tax preparers were adversely affected. Read a copy of the IRS Notice here.

No filing and payment penalties will be due as long as returns are filed and payments are made by July 15, 2013.

Sunset Provisions: Business and Investment

Many of the “Bush-era” tax cuts are scheduled to sunset at the end of 2012. The “Bush-era” tax cuts is the collective term for the tax measures enacted in the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) and the Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA). These two Acts made changes to over 50 provisions of the Internal Revenue Code and impacted a wide variety of taxpayers. However, in order to comply with budget requirements, the changes are scheduled to expire. In a presidential election year, it is not clear what, if anything, Congress will do to extend these tax cuts. This uncertainty in the tax law generates a myriad of complexities for taxpayers and tax professionals.

The following are highlights of some of the business and investment tax cuts scheduled to expire after 2012 and what might happen if they are not extended.

Capital Gains

The reduced maximum capital gains rate of 15 percent on adjusted net capital gain of noncorporate taxpayers and the zero percent capital gains rate on adjusted net capital gain of noncorporate taxpayers in the 10-percent and 15-percent income tax bracket are scheduled to expire for tax years beginning after December 31, 2012.

Impact – Absent extension, the maximum tax rate on net capital gain of noncorporate taxpayers will revert to 20 percent (10 percent for taxpayers in the 15 percent bracket) after 2012. Thus, the acceleration of the sale of capital assets into 2012 while the tax rates are lower is one strategy for taxpayers to consider. As long as the sale is bona fide, and the proceeds are received in 2012, capital gains can be accelerated. The “wash sale” rules that apply to claiming losses do not apply to gains. Accordingly, capital gains can be recognized at any time and, immediately thereafter, the identical asset can be repurchased, with a new tax basis established in the amount of the purchase price.

Accordingly, installment payments received after 2012 are subject to the tax rates for the year of the payment, not the year of the sale. Thus, the capital gains portion of payments made in 2013 and later may be taxed at the 20 percent rate.

Five-Year Holding Period for Capital Assets

There is no special capital gain treatment in 2011 or 2012 for property held for more than five years. After 2012, the JGTRRA-based lower capital gain rates for five-year gain of individuals, estates and trusts are scheduled to be revived. Long-term gain on the sale or exchange of property held for more than five years generally will be taxed at 18 percent (eight percent for taxpayers in the 15 percent bracket).

Impact – For higher-income taxpayers, the 15 percent rate applies if the taxpayer has held the asset for more than one year, but only if the taxpayer sells the asset by no later than December 31, 2012. The 18 percent rate for qualified five-year property applies if the taxpayer acquired the asset in 2001 or later, has held the asset for more than five years, and sells it after December 31, 2012. The 20 percent rate applies if the taxpayer acquired the asset in 2001 or later, sells the asset after December 31, 2012 and has held the asset for more than one but not more than five years; or has held the asset for more than five years but acquired the asset by exercising an option, right or obligation to acquire the property and the taxpayer has held such since before 2001.


The 2010 Tax Relief Act extended the reduced net capital gains tax rates for qualified dividends through 2012. These rates had originally been enacted by JGTRRA. The maximum tax rate for qualified dividends received by an individual is 15 percent for tax years beginning before January 1, 2013. A zero percent rate applies to qualified dividends received by an individual in the 10 or 15 percent income tax rate brackets.

Impact – Absent extension, qualified dividends will be taxed at the applicable ordinary income tax rates after 2012 (with the highest rate scheduled to be 39.6 percent). Qualified corporations may want to explore declaring a special dividend to shareholders before January 1, 2013. President Obama’s proposed fiscal year (FY) 2013 federal budget recommended increasing the dividends rate to the ordinary income tax rate for higher-income individuals.

Other Dividend-Related Provisions

The following business-entity related tax breaks associated with dividends are also scheduled to sunset after 2012:

Dividends received from a regulated investment company (RIC), real estate investment trust (REIT) and other qualified pass-through entities are treated as qualified dividends for purposes of the reduced tax rates through 2012;
Temporary repeal of the collapsible corporation rule will end after 2012;
The accumulated earnings tax rate imposed on corporations which had been reduced to 15 percent will rise to 39.6 percent after 2012; and
The tax on undistributed personal holding company (PHC) income will also rise from its temporary 15 percent rate to the highest individual tax rate.

Uncertainty is always a factor in tax planning. In 2012, uncertainty is magnified by the unknown fate of countless tax provisions on which taxpayers have relied in recent years. The uncertainty is expected to continue until after 2012 elections; and maybe even into 2013. Our office can help you plan for all of this uncertainty, by adopting strategies that allow you to remain flexible for as long as possible while being prepared to act on opportunities before they are lost to time and changing laws. Making plans now to accelerate certain income, defer specific deductions, and realize capital gains are only some of the strategies that might fit your situation.




Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

Take Advantage of Lower Tax on Capital Gains

Long-term capital gains and qualified dividends continue to be taxed at favorable rates through 2012. For middle- and higher-income investors, these items are taxed at a maximum rate of 15 percent, a much lower rate than ordinary income. Taxpayers in the 10 and 15 percent ordinary income brackets do not pay any taxes on long-term gains and qualified dividends. Short-term gains are taxed at ordinary income rates.

To obtain long-term rates, investors must hold the asset (such as stock and most other property) for more than one year. The holding period begins on the day after you acquire the asset and ends on the day you dispose of the asset.

Example. If you bought stock on November 30, 2010 and sold it November 30, 2011, your holding period is exactly one year, and any gain (or loss) is short-term. If you instead sold the stock on December 1, 2011, your holding period is more than one year, and gains (or losses) are long-term.

Rates on long-term gains may increase dramatically after 2012, depending on the status of the Bush-era tax rates. Long-term rates will increase to 20 percent if Congress takes no further action. The Obama administration has proposed to reinstate the 20 percent rate, but only for individual taxpayers with income of $200,000 and married taxpayers with income of $250,000. To ensure that you can take advantage of long-term rates in 2012, you may want to make particular stock purchases before the end of 2011. For 2011, December 30 is the last day on which stock exchanges are open, since December 31, 2011 is a Saturday.

2011 Second Quarter Federal Tax Developments

During the second quarter of 2011, there were many important federal tax developments. This highlights some of the more important federal tax developments for you. As always, please give our office a call or send us an email if you have any questions about these developments.

Mileage rates. The IRS announced a mid-year adjustment to the 2011 optional mileage rates to reflect an increase in gasoline prices since the rates were set in late 2010. The business standard mileage rate rises to 55.5 cents-per-mile and the medical/moving standard mileage rate to 23.5 cents-per-mile, both representing a 4.5 cents-per-mile increase for the second half of 2011. The charitable standard mileage rate, which is determined by statute, is unchanged for the second half of 2011.

Information reporting. In April, President Obama signed the Comprehensive 1099 Taxpayer Protection and Repayment of Exchange Subsidy Overpayments Act of 2011 (2011 Taxpayer Protection Act) (P.L. 112-9). Previously, the Patient Protection and Affordable Care Act (PPACA) (P.L. 111-148) required businesses, charities and government entities to file information returns (Form 1099) for all payments of $600 or more in a calendar year to a single vendor, other than to a tax-exempt vendor, made after December 31, 2011. The PPACA also repealed the long-standing reporting exception for payments made to corporations. The Small Business Jobs Act of 2010 (2010 Small Business Jobs Act) (P.L. 111-240), required landlords to file a Form 1099 to report certain rental property expense payments of $600 or more in conjunction with their rental properties. Reporting under the 2010 Small Business Jobs Act was mandated for qualified payments made after December 31, 2010. The new law repeals these reporting requirements as if they had never been enacted.

Foreign accounts. In February 2011, the Treasury Department’s Financial Crimes Enforcement Network (FinCEN) issued final rules under the Bank Secrecy Act for reporting certain foreign accounts. Subsequently, the IRS and FinCEN announced a one-year extension of filing Form TD F 90-22.1, Report of Foreign Bank and Financial Accounts (FBAR) for certain individuals and certain financial professionals with signature authority over, but no financial interest in, foreign financial accounts. Additionally, the IRS suspended certain information reporting requirements under the Foreign Account Tax Compliance Act (FATCA) title of the Hiring Incentives to Restore Employment (HIRE) Act (P.L. 111-147).

In January 2011, the IRS announced an offshore voluntary disclosure initiative (OVDI) to encourage taxpayers to report undisclosed foreign accounts. In exchange for making voluntary disclosure of unreported foreign accounts and fully cooperating with the IRS, taxpayers may be eligible for a reduced penalty framework. The 2011 OVDI will be available only through August 31, 2011. In limited situations, however, the IRS will consider extending that deadline for up to 90 days upon a taxpayer’s request and a good faith showing that all relevant materials cannot be submitted by the August 31, 2011 deadline. The IRS also provided opt-out procedures.

Filing season. As of the morning of the April 18 filing deadline, IRS reported that e-filed tax returns had topped the 100 million mark during the 2011 tax filing season, a record for e-filing. The 100 million figure represents an 8.8 percent increase from the 2010 tax season.

Basis. In Carpenter Family Investments, LLC, 136 TC No. 17, the Tax Court rejected IRS regulations that impose an extended six year limitations on assessments due to overstated basis. The court found that events since its last decision on the issue – namely, issuance of final regulations and Supreme Court’s Mayo (131 SCt 704 (2011) decision – did not change its holding that the IRS is limited to the general, three-year limitations period in basis-overstatement situations.

Whistleblower awards. The IRS whistleblower program was significantly overhauled in the Tax Relief and Health Care Act of 2006 (P.L. 109-432). In April, the IRS described how the agency may pay whistleblower awards and impose income tax withholding on awards. Additional guidance is expected as the agency moves forward in finalizing proposed regulations, the IRS reported.

Withholding. The IRS issued final regulations explaining when governmental entities must withhold three percent on payments they make to contractors providing property or services. The final regs delay the effective date of the withholding requirement until payments made after December 31, 2012. Among other provisions, the regulations will generally only apply to payments of $10,000 or more. The withholding requirement, enacted in the Tax Increase Prevention and Reconciliation Act of 2005 (P.L. 109-222), remains controversial and is the subject of numerous repeal measures in Congress.

Health care reform. In April, the IRS expanded interim relief from reporting the cost of employer-provided health insurance coverage on Forms W-2, Wage and Tax Statement. Under the Patient Protection and Affordable Care Act (PPACA) (P.L. 111-148), employers generally are required to report the cost of coverage on Forms W-2 starting with Forms W-2 issued in 2012 for the 2011 tax year. In Notice 2010-69, the IRS issued interim relief, making reporting optional for all employers for 2011. Notice 2011-28 provides further relief.

The IRS released in May a framework on how it may implement the employer’s shared responsibility requirements under the Patient Protection and Affordable Care Act (PPACA) (P.L. 111-148). The framework describes which employers may be affected and how the number of employees and any assessable payments will be calculated. The PPACA does not require employers to provide health insurance to their employees but imposes assessable payments on certain large employers after 2013 that generally fail to offer full-time employees the opportunity to enroll in minimum essential coverage under an employer plan or offer full-time employees the opportunity to enroll in minimum essential coverage but, among other things, the minimum essential coverage is unaffordable and an employee receives a tax credit or cost-sharing.

Health savings accounts. The IRS provided inflation-adjusted amounts for health savings accounts (HSAs) for 2012. The amounts generally increased from 2011. For calendar year 2012, the annual contribution limit for an individual with self-only coverage under a high deductible health plan (HDHP) is $3,100, up from $3,050 for calendar-year 2011. The corresponding limit for an individual with family coverage under an HDHP is $6,250, up from $6,150 for calendar-year 2011. For calendar year 2012, an HDHP is defined as a health plan with an annual deductible that is not less than $1,200 for self-only coverage and $2,400 for family coverage. These amounts are unchanged from calendar year 2011.

Killer B transactions. The IRS issued final regulations that target so-called Killer B stock-for-stock triangular reorganizations that some domestic parents have used to repatriate the earnings of foreign subsidiaries tax-free. The final regulations generally track proposed regulations issued in 2008, and apply to transactions occurring on or after May 19, 2011.

Innocent spouse relief. In June, the Court of Appeals for the Fourth Circuit upheld the two-year limitations period for requesting Code Sec. 6015(f) equitable innocent spouse relief (Jones, CA-4, June 14, 2011). The Fourth Circuit concluded that the regulations represented a reasonable approach to resolving ambiguity. The Tax Court previously found the regulations invalid.

FUTA surtax. The 0.2 percent federal unemployment act tax (FUTA) surtax expired after June 30, 2011. Prior to July 1, 2011, FUTA was made up of the permanent 6.0 percent rate and the 0.2 percent surtax for a combined tax rate of 6.2 percent. The 0.2 percent surtax, originally enacted in 1976, had been extended by the Worker, Homeownership and Business Assistance Act of 2009 (2009 Worker Act) (P.L. 111-92) through 2010 and the first six months of 2011. As a result of the expiration of the surtax, the FUTA tax rate falls to 6.0 percent before any state unemployment tax credits are taken into account.

If you have any questions about these or any federal tax developments, please contact our office.

 Reproduced with permission from CCH’s Client Letter, published and copyrighted by CCH Incorporated, 2700 Lake Cook Road, Riverwoods, IL 60015.

Next Page »