Do you have children or grandchildren who plan to attend college in the future? Do you have a dependent in college now? Are you considering going back to college to finish a degree or start a graduate degree program? As the cost of a college education continues to increase, understanding the tax implications of saving and paying for tuition is an important step in the process.

Using 529 Plans to Save and Pay for Higher Education

The qualified tuition program (more commonly known as a 529 Plan) is a great way to save and pay for college. While other options exist, 529 Plans are simple to set up, easy to use and provide the most flexibility.

How Does It Work?

• Open a 529 Plan with a brokerage firm, choose an investment plan, and deposit funds for a designated beneficiary.
• Balances in a 529 Plan grow tax-free enabling you to take advantage of compound interest before the beneficiary needs the money for future expenses.
• Withdrawals used for qualifying expenditures are non-taxable.
• Qualifying expenditures include:
  • Tuition, fees, books, supplies & equipment required for enrollment at an eligible postsecondary institution.
  • Room and board expenses incurred by a beneficiary enrolled at least half-time at an eligible postsecondary institution.
  • Costs of certain computer equipment, software, internet access and related services.
  • Elementary or secondary school tuition expenses of up to $10,000 per year for a designated beneficiary.
  • Costs of fees, books, supplies and equipment required for certain registered apprenticeship programs.
  • Student loan repayment up to a $10,000 lifetime cap.

Are Contributions to 529 Plan Tax-Deductible?

Contributions to 529 Plans are not deductible on your federal tax return. However, many states provide deductions for at least a portion of your contributions. For instance, Kansas allows an annual deduction of up to $6,000 per beneficiary for joint filers or up to $3,000 per beneficiary for all other filers.

How Much Can I Contribute?

Contributions are only limited by the amount necessary to provide for the qualified education expenses of the beneficiary. Gifts in excess of $15,000 annually per beneficiary may be subject to gift tax return filing requirements.

What Happens if the Money Is Not Needed?

Assets in a 529 Plan can be transferred from one plan to another. Beneficiaries can also be changed without transferring accounts.

However, if funds are not used for education expenses, the earnings portion of any distributions used for non-qualified expenses will be taxable and may also be subject to a 10% early withdrawal penalty.

Higher Education Tax Credits

Many taxpayers may also be eligible for tax credits on the amounts paid for qualifying education expenses. The two tax credits currently available are known as the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Tax Credit (LLTC). Know the rules so you can maximize your tax savings.

How Much Are the Credits?

• The AOTC is up to $2,500 annually per eligible beneficiary.
• The LLTC is up to $2,000 annually per tax return.

How Are the Credits Calculated?

• The AOTC is calculated at 100% of the first $2,000 of qualified expenses and 25% of the next $2,000 of qualified expenses.
• The LLTC is calculated at 20% of the first $10,000 of qualified expenses.

What Are Qualified Expenses?

• For the AOTC, qualified expenses include tuition, required fees and course materials for a student enrolled at least half-time during the first four years of an undergraduate degree program and only four total years of the credit may be claimed per eligible student.
• For the LLTC, qualified expenses include tuition and required fees for all years of postsecondary education regardless of whether they are in a degree program and the credit can be claimed for an unlimited number of years.

Is Everyone Eligible for the Credits?

Unfortunately, there are income limitations depending on your filing status. Talk to your tax accountant if you have questions about your eligibility.

Anything Else I Need to Know About these Tax Credits?

• If the student is being claimed as a dependent, the credit is available to the taxpayer claiming the student on their tax return, regardless of who actually paid the tuition expenses.
• If a student could be claimed as a dependent, the student is not eligible to claim the credit on their return.

Tuition expenses paid by a 529 Plan are not eligible for the education tax credits. However, your tax accountant can help you use available strategies to maximize your tax savings using a combination of both 529 Plans and education credits.