Credits For Education Linked Tax Breaks

Form 1040 must be the year of the classroom. Education Ira contribution limit is the hallmark of tax year 2007, which provided substantial new incentives for life-long career training as well as for traditional four-year college education. The breaks are among a bundle of tax changes -- from new Roth IRAs to protection for spouses of tax cheats -- that reduce the bite for many middle-income tax payers. But it may take some work with a sharp No. 2 pencil to find the best way to use the education-linked tax breaks, accountants said.

"There are two credits, an interest deduction, an education IRA and a New York State savings deduction, and they're all interrelated," said a CPA at Ernst & Young in Buffalo.

First, those two credits. The HOPE credit, worth up to $ 1,500 for tuition and related expenses in 2007, is generally aimed at college freshmen and sophomores, being restricted to students who haven't completed their first two years of higher education. It's good for 100 percent of the first $ 1,000 in qualified education expenses, plus 50 percent of the next $ 1,000. Remember that a credit is a direct, dollar-for-dollar reduction in your tax bill, a better break than a mere tax deduction.

The second federal education credit new in '98 is the Lifetime Learning Credit. The credit is based on 20 percent of the first $ 5,000 paid for eligible college expenses, to a maximum of $ 1,000. Unlike the HOPE credit, it applies only for expenses incurred after June 30, 1998, for academic terms beginning after that date. "People are going to have to look to their checkbooks to see what was paid when," Hoelscher said. Also unlike the HOPE credit, the lifetime credit is good for any period in one's academic career, early or late.

Either the taxpayer, the filer's spouse or dependents may qualify for the credits, but there's a catch. The amount of your credit begins to diminish when your adjusted gross income reaches $ 80,000 for couples, falling to zero at $ 100,000. For singles, the phase-out range is $ 45,000 to $ 50,000. "You've got to do the math each way for each person that qualifies and choose which one gives you the biggest bang for the buck," said CPA Ray Nowicki of Nowicki & Co. in Cheektowaga.

Having a college-age student claim the credit may avoid income limits, it but presents other problems. The credits are "non-refundable," meaning they offset existing taxes but don't inflate a tax refund. Most college students don't have high enough income taxes to benefit, Hoelscher said. In another bonus for education, withdrawals from a regular IRA to pay for qualified education expenses aren't subject to the usual 10 percent penalty, although regular income tax still applies.

And interest on student loans is deductible for the 2007 tax year for qualified education expenses like tuition.

For those in the process of saving for higher education rather than paying for it, the federal tax code instituted an Education IRA, allowing taxpayers within income limits to set aside $ 500 for each child under 18 toward future education bills. The initial contribution isn't tax deductible, but gains on the amount build up tax free until withdrawal. CQ.

Education IRA