A New Deduction for Education Expenses - beginning 2002.
Effective January 1, 2002, taxpayers may be eleigible to deduct from income a
portion of the fees paid for tuition and other qualified education related
expenses directly from their income. This is a deduction from total income
before Adjusted Gross Income subject to income phaseout limits.
deductible expenses are defined by the rules for education credits
you don't have to itemize to claim the deduction
if your income is too high, you don't get the deduction
The maximum deduction is:
Tax year 2002
$3,000
Tax year 2003
$3,000
Tax year 2004
$4,000
Tax year 2005
$4,000
The deduction expires after December 31, 2005.
The deduction is phased out for taxpayers above a certain income limit and its
not available to married filing separate taxpayers, dependents, and certain
non-resident alien spouses.
The amount of the deduction is reduced by the amount of interest excluded from
income from US Savings Bonds, the earnings portion of Section 529 plans, and
all distributions from Educational IRAs.
The income limitation is based upon "modified adjusted gross income" which
requires the adding back of certain non-taxable sources of income. It is
expected that the IRS will create another worksheet to assist with this
calculation.
A taxpayer cannot take an education credit and the deduction for the same
student in the same year. While credits are usually preferable, it may be that
the lower Adjusted Gross Income resulting from taking this deduction would
result in more tax savings. Possible situations would be:
a low income tax payer trying to maximize Earned Income Credit
high income taxpayer needing to lower taxable income in order to minimize the
impact of the Alternative Minimum Tax where a regular tax credit is not helping
them.
Tax preparers will need to compare the alternatives to determine which will
give the greatest tax savings.
These upcoming changes to the tax treatment of education expenses will add a
lot of complexity to an already difficult issue. Taxpayers will need to keep
track of
out-of-pocket expenses,
distributions from Educational IRAs
distributions form Section 529 plans,
the earnings within any Section 529 plans and
the fair market value of the plan at the time each distribution is made.
Also, it will be necessary to make sure the each expense is qualified. Each
distribution will have to be matched with the related expense that it pays.
More than ever it appears that affected taxpayers will need to keep in close
contact with their tax advisor in order to maximize their tax savings. Tax
preparers will need to be very familiar with all the applicable rules and
limitations to accurately determine the most tax advantageous scenarios.
All information provided is general in nature and intended to create awareness,
not to address the specific circumstances or concerns of any individual or
entity. Although we try to provide correct and timely information, we cannot
guarantee the accuracy of any information or that such information will
continue to be accurate in the future due to the changing nature of the tax
laws. Before acting on any of the information provided here, you should consult
with a professional advisor who knows all of the unique facts and circumstances
pertinent to your particular situation.
Tax Info Newsletter