Over the years, Congress has continued to enhance tax breaks for students and their parents. These tax benefits provide taxpayers with a large number of options for tax-favored financing of their education and the education of their family members. This brochure highlights the various education benefits included within the U.S. income tax system. Coverdell Education Savings Account (Education IRA) Qualified State Tuition Program American Opportunity Credit Lifetime Learning Credit Penalty-Free IRA Withdrawals for Education Purposes Deduction for Education Loan Interest Tax-Free Savings Bond Interest Student aid is available from the Department of Education for students of limited means. The aid can include educational grants such as a “Pell” grant or various types of student and parent educational loans. Planning and saving for future education can limit or eliminate potential student aid, because these resources will be taken into consideration at the time the need for student aid is determined. Understanding the tax terms: You will encounter several tax terms in this brochure that may be unfamiliar to you. Understanding their full meaning will help give you a better picture of the limits, qualifications, and restrictions that apply to the benefits for education. Phase Out... Instead of just eliminating certain deductions and credits, the tax law often decreases them gradually to zero (“phases them out”) over a specific income range. For example, say a hypothetical $1,000 deduction is allowed, but “phases out” when a taxpayer’s “modified adjusted gross income (AGI)” is between $40,000 and $60,000. A taxpayer with a modified AGI of $40,000 or less will be allowed the full $1,000 deduction, while the taxpayer with a modified AGI of $60,000 or more would get no deduction. For modified AGIs between $40,000 and $60,000, the taxpayer would be allowed a pro-rated deduction amount. Regular AGI and Modified AGI... AGI is the abbreviation for “adjusted gross income.” “Regular AGI” is the total of all income, allowable losses, and adjustments before subtracting itemized or standard deductions and, for years other than 2018 through 2025, personal exemptions. However, several tax benefits described in this brochure are limited or not available to taxpayers whose so-called “modified AGI” is too high. Generally, the modified AGI for educational benefits adds back certain amounts from foreign, U.S. Possession, and Puerto Rican sources that are excluded from income. Qualified Educational Institutions... These Institutions are generally accredited, post-secondary educational institutions that offer credit toward a bachelor’s degree, an associate’s degree, or some other recognized post-secondary credential. Certain proprietary institutions and post-secondary vocational institutions also qualify if they are eligible to participate in Department of Education student aid programs. Coverdell Education Savings AccountOriginally referred to as an Education IRA, the Coverdell Education Savings Account is actually a nondeductible education savings account. The investment earnings from this account accrue and are withdrawn tax-free if the proceeds are used to pay qualified education expenses of the account beneficiary. Contributions are only allowed for designated beneficiaries under the age of 18 and the allowable nondeductible contribution is $2,000 per year per beneficiary. The annual contribution limit is gradually reduced if the contributing taxpayer’s “modified AGI” is within the phase-out range and eliminated for taxpayers above the range, which for married taxpayers filing jointly is $190,000 – $220,000 and $95,000 – $110,000 for single taxpayers. Unlike phase-outs for many other tax benefits, these amounts are not adjusted annually for inflation and have not changed since 2002. Anyone is allowed to make the contribution provided the total contribution for the under 18 beneficiary does not exceed the annual contribution limit and the contributing taxpayer’s AGI is within limits. If the AGI limits the contribution, the funds can be gifted to someone else whose contribution would not be AGI limited, even the beneficiary. Distributions from the Coverdell Education Savings Account are tax- and penalty-free (including interest on the account) if they are used to pay for qualified education expenses of the designated beneficiary or a member of the beneficiary’s family. The definition of qualified education expenses includes elementary or secondary education, kindergarten through grade 12, as well as post-secondary education. Because of the phase-out provision for contributions, taxpayers cannot always be sure they can contribute to the accounts. Recognizing this problem, the tax law permits Coverdell contributions to be made after the close of the tax year for which the contribution is being made and before the April 15 filing due date for that year. (Note: if the April 15 due date falls on a Saturday, Sunday or holiday, the due date is the next business day.) Additional rules apply for dealing with rollovers, changes in designated beneficiaries, death of taxpayer or beneficiary, excess contributions, special needs beneficiaries, and unauthorized use of distributions. Qualified State Tuition ProgramsA qualified state tuition program is one generally set up by a state or state instrumentality that lets individuals make contributions to an account established for a designated beneficiary’s higher education. Unlike the Coverdell Education Savings Account, there is no limit on the annual contributions to Qualified State Tuition programs. However, contributions to these plans are considered gifts to the beneficiary, making the annual gift exclusion amount the practical annual limit per contributor. The annual gift exclusion amount is inflation-adjusted periodically and is $15,000 for 2019; please call this office for the limit for other years. A special rule allows a donor who makes total contributions exceeding the annual gift limit to elect to take the contributions into account ratably over a five-year period, starting with the year of the contribution. This allows a donor to contribute as much as $75,000 (2019) in one year, while avoiding the gift tax implications. The donor must file a gift tax return for the year of the contribution, and a five-year election must be made on the return. Care should be exercised in determining the total contributed to any individual’s account to avoid nonqualified distributions if the amount exceeds the educational needs. Virtually all of the high population states now have these programs, which are professionally managed and tailor the investments and risk potential to the prospective student’s current age. Individuals are not restricted to using the program established in their home state but instead can pick and choose among the programs of any of the states that have established programs. A major benefit of these programs is that the distributions of earnings from the programs can be excluded from income if used for qualified education expenses. This puts the Qualified State Tuition Programs on par with Coverdell Education Savings Accounts, but without the annual contribution limit. However, unlike Coverdell plans that allow tax-free distributions to pay for grades K-12 expenses, distributions through 2017 from QSTPs were only used for post secondary education expenses. For years after 2017, tax reform added withdrawals for elementary or secondary school tuition expenses but limits the annual withdrawal for each beneficiary to $10,000 (regardless of the number of 529 plans in the beneficiary’s name). This special $10,000 amount applies for tuition paid to public, private or religious schools.