CHANGE AGENT #10 -- TAX ADVANTAGES & COLLEGE COSTS

by Mike Szydlowski, Director of Financial Aid, Woodberry Forest School

There are many tax advantages available to help pay the costs of a college education.  Here are some suggestions that you can share with your full pay and partial pay families.

1)  The rules that apply to early distribution of IRA assets have been relaxed.  A family may now withdraw proceeds from an IRA to pay qualified costs which include tuition, fees, books, supplies and, if the student is at least half-time, room and board.  The withdrawal is not subject to the 10% early withdrawal penalty but at least some of the distribution is taxable income.  Beware; this early withdrawal provision does not apply to Roth IRA’s.

2)  If parents intend to pay college costs from the proceeds in their 401 retirement plans they should borrow the money from their account instead of taking a distribution.  The taxable amount of a distribution will show up on next years Form 1040, therefore on next years FAFSA/CSS Profile.

3)  Similarly, remember that a students earnings from Federal Work Study is not included in the students income for next years FAFSA.  This is a good reason for the student to remain in work-study rather than work ‘off-campus’.

4)  If grandparents plan to help pay college costs they should make payments directly to the school instead of ‘gifting’ the money to the student or to his parents.  This direct payment of tuition (room and board does not qualify) does not trigger the gift tax limitation.  Example:  Total college cost is $25,000, $18,000 tuition and $7,000 room and board.  Grandparents can pay the tuition directly to the school and then gift the $7,000 either to the student or the parents.  The annual gift exclusion is now $11,000 so the gift tax limitation is not triggered.

5)  Many families cannot take advantage of the Hope or Lifetime learning credits because their income exceeds certain thresholds.  This also applies to the student interest deduction and the new Higher Education Tax Deduction.  Income shifting may help these families take advantage of these provisions of the tax code.  Example:  If parents plan to sell assets to pay college costs they may wish to consider giving the assets to the child for him to sell rather than selling the assets themselves.  The reason?:  Assume the parents have a $20,000 asset with a $5,000 basis.  They can gift it to the child without triggering the gift tax limitation.  When the child sells the asset he will owe tax on $15,000 (market value – basis).  After applying the personal exemption and the standard deduction his taxable income will be $7,300.  He will owe $730 tax (his rate is the 10% capital gains tax rate, the parents tax rate would have most likely been 20%).  However, he will be able to apply either the Hope or the Lifetime Learning credit, which will eliminate any tax liability.  Income shifting is only for those families who know they will not qualify for need based aid and who feel comfortable working inside of the tax code to take advantage of their options.  This example also opens the question of dependent vs. independent student status.  Generally, if the family’s income is above $130,000 they cannot take advantage of any of the credits or deductions for college expenses.  These families should consider income shifting which allows the student to claim his own deduction when filing his tax return.  Of course the parents will lose the exemption write-off for that child but at that income level they cannot take the full value of the exemption anyway.

Contact:  Email:  mike_szydlowski@woodberry.org, Phone:  (540) 672-6054