Tax Savings for College Education Cost

Saving on the cost of a college education comes in many forms.  For instance, to save on the expense of tuition and books, you have a choice of several government programs, scholarships, loans, and even private money.  However, in addition to the more standard type of financial aid, you could save on the cost of a college education by looking at tax savings.  As you will find in this article, you have a number of possibilities, some that would benefit immediately and some long-term.

As discussed below, there are ways to move earned and unearned income to a student to use income to pay the cost of a college education without any or at least very little federal income due on that student’s tax return.  Keep in mind that tax saving opportunities specific to college are in abundance such as prepayment of tuition for college, direct tuition payment to certain educational institutions, and even using different business entities.  However, because there are so many options to consider, we provided just a few examples.

As mentioned, it is possible to move earned income to a college student which in essence, means that you would pay your child opposed to being paid yourself.  Now, the only way this tax savings would work is if you work for yourself or have your own business.  In this case, your child who wants to attend college would be hired as your employee.  Of course, this means having a real job that would pay a competitive rate.  As a part of having the job, your child would be required to pay applicable withholding taxes.

If you wanted to move unearned income to your child to enjoy tax savings for a college education than this would be possible through unrealized capital gains associated with the gift of appreciated assets.  The current tax law shows $13,000 a person is approved as an annual exclusion.  In this case, if you were to pay your child more than this within any given year, two things would happen.  First, your child’s exemption on a lifetime basis would be reduced and second, your child would be required by law to file a gift tax return.

For tax savings on college, you should also know about the American Opportunity Tax Credit.  If you do not claim this on your taxes and your child is not claimed as an exemption, then this tax credit could be claimed by your child.  In addition, your child could claim the Lifetime Learning Tax Credit, the Hope Scholarship Tax Credit, and tuition, as well as fees when filing taxes.

The American Opportunity Tax Credit has a current value of $2,500 per student attending a four-year college or university.  For income phase out, this ranges from $160,000 to $180,000 specific to modified adjusted gross income for joint returns.  Then for the calculation used, this is based on 100% for the first $2,000 of the money but only for qualified tuition and fees being paid.  Along with this, 25% of the following $2,000 would also be paid for the same expenses.  Now, if the amount of income phase out were less, this refundable credit would be worth up to $1,000, excluding any dependent children.

One last piece of advice for tax savings on college is to make sure the Kiddie Tax is avoided.  This tax is connected to unearned income paid to children under the age of 18.  Now, during the year 2011, $950 of this income would not be taxable whereas the second $950 would be.  In addition, any unearned income more than $1,900 is taxed but at the rate charged to you as the parent.  According to new laws, the Kiddie Tax is now for children 19 and under, as well as students attending college full time who are 24 years of age and less.

For students in this last group, the Kiddie Tax can be avoided but only if more than 50% of support comes from earned income.  In this case, let us say your child had chosen a college or university with tuition of $30,000.  This means with more than 50% of support coming from earned income in the amount of $20,000, the Kiddie Tax would not apply but again, only if a full-time student going to a four-year college or university and being 24 or less.

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