Tuesday, September 15, 2009

Education tax credit sweetened

http://www.latimes.com/business/la-fi-perfin13-2009sep13,0,6813339.column
The incentives have been bumped up to as much as $2,500 per student and are now available to families earning up to $180,000. But the tax break is good only through 2010.
By Kathy M. Kristof Personal Finance
September 13, 2009

Parents: Save those education receipts.

For the first time -- and for a limited time -- upper-middle-income parents will be able to take advantage of huge tax breaks for paying college bills.

This is thanks to a law that temporarily supplants the Hope Tax Credit with the far more lucrative and inclusive American Opportunity Tax Credit.

What's this law and how can you take advantage of it?

The American Opportunity Tax Credit is one of several generous tax breaks that were passed into law in February as part of the American Recovery and Reinvestment Act, aimed at stimulating the U.S. economy.

It provides a federal income tax credit equal to 100% of the first $2,000 in qualified education expenses and 25% of the next $2,000 in expenses per student for qualified families.

That's a total of up to $2,500 in tax credits per student. It also bears mentioning that tax credits are far more valuable than tax deductions because credits reduce your tax on a dollar-for-dollar basis. Deductions just reduce the amount of income subject to tax.

However, this break is available only for 2009 and 2010. After that, the American Opportunity Tax Credit expires.

Who can claim the credit?

Three criteria determine whether you qualify:
  • You must be paying higher education expenses such as tuition, fees, books and supplies for a student who is seeking a degree, certificate or credential and attending school at least half time.

  • The student must be you or a qualifying dependent, such as a spouse, child or stepchild.

  • Your income must not exceed certain thresholds.

Single filers are eligible for a full credit unless their "modified adjusted gross income" exceeds $80,000 and for partial credits if they earn less than $90,000, at which point they are no longer eligible to claim the credit.

Married couples can get the full credit with up to $160,000 in income and a partial credit with up to $180,000 in modified adjusted gross income.

What's modified adjusted gross income?

That's an important question. It starts with adjusted gross income, which is all your earnings -- wages, tips and investment income -- minus contributions to workplace benefits and retirement programs such as 401(k) plans, dependent care accounts and health savings accounts. Modified adjusted gross adds in some relatively rare sources of tax-free income, such as income earned overseas. For most people, "modified adjusted gross" is simply adjusted gross income.

Why is that such an important question?

Because you can manipulate your adjusted income by boosting your contributions to workplace benefit plans or self-employment retirement plans.

If your income exceeds these thresholds, Santa Barbara tax specialist Jennifer MacMillan suggests you look carefully at reducing that figure by contributing as much as possible to qualifying plans. It can make a huge difference in your tax liability, she adds.

A family of four earning $170,000, with two children in college, for example, would lose 50% of the American Opportunity Tax Credit if they did nothing. Because they would get two credits -- one for each child -- they'd lose out on $2,500.

If each parent put $5,000 into deductible retirement accounts, it pushes their modified adjusted gross under the threshold, generating another $2,500 in tax credits.

By doing this, they'd also reduce their taxable income, which, assuming a combined federal and state income tax rate of 30%, would save them $3,000 more. The bottom line: Saving an extra $10,000 in retirement plans returns $5,500 in tax savings.

Can my child claim the credit, if I can't meet the income thresholds?

Yes. But you would not be able to claim your child as a dependent, so this would work only for college students and graduate students who have significant other income and are largely able to support themselves.

Can I use the credit to recover the cost of room and board at college?

No. Qualified expenses are tuition, fees, books and supplies.

How do I claim it?

You must fill out a 29-line work sheet, Form 8863, said Jackie Perlman, a tax specialist at H&R Block in Kansas City.

This form was previously used to claim the Lifetime Learning Credit and the Hope Tax Credit, which the American Opportunity Tax Credit largely replaces for 2009 and 2010.

However, because there are a few instances when you might still try for a Hope Credit (mainly if you attend college in a Midwestern disaster zone) the form is twice as complicated as it was last year. If you prepare your own return, make sure to read the instructions carefully.

Do I need to send in tuition bills or any other evidence of my expenses?

No. Just keep them with your records, Perlman said, and keep your records at least four years.

What happens if I have college expenses after 2010? Will I still get a tax break?

Maybe. Congress could extend this break, or you might qualify for another one. However, the other tax breaks for college students in current law are not as generous, and most have lower qualifying earnings restrictions.

kathykristof24@gmail.com