When college mixes with taxes, time to unravel the knot

Posted 3/7/17

For people who enjoy the challenge of mazes, a huge opportunity presents itself every year in the mix of college financial aid applications and income tax returns. What a labyrinth of rules and potential deductions and credits you can …

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When college mixes with taxes, time to unravel the knot

Posted

For people who enjoy the challenge of mazes, a huge opportunity presents itself every year in the mix of college financial aid applications and income tax returns. What a labyrinth of rules and potential deductions and credits you can encounter!

But for those folks who DON’T enjoy this kind of puzzle, it’s almost enough to make you cry.

The government has tried to make this process logistically simple, allowing one document (your tax return) to be used as a tool to fill out the other document (your FAFSA — the Free Application for Federal Student Aid). But then things start to get complicated. For instance, for the 2017-2018 college year, parents of college-bound children will utilize their 2015 income tax information to complete the FAFSA — NOT their 2016 tax return.

The next twist in the maze comes when parents discover that their children are not eligible for financial aid. That’s when they should consider looking to their tax return for some assistance to help with the tuition and other costs. There are 11 different sections in the Internal Revenue Code that offer tax credits, adjustments or deductions for post-secondary expenses. Most of these are sensitive to the taxpayer’s adjusted gross income, or AGI, but not all.

The State of Colorado also allows a near limitless subtraction (against income) for contributions to CollegeInvest®, the Colorado-sponsored 529 program — presuming the contributions are made by a Colorado resident.

The most generous of the federal tax credits is called the American Opportunity Tax Credit. This credit (and credits are directly against tax) was made permanent Dec. 2015. The basics of the AOTC are that the taxpayer receives a credit of 100 percent of the first $2,000 of qualified education expenses, and 25 percent of the next $2,000 of qualified education expenses. The maximum credit (per student, per year) is $2,500, limited to four years of post-secondary education. Qualified expenses include tuition and certain mandated fees, plus course books and materials, which can, in some cases, include laptops and other computers.

A student’s eligibility is dependent upon several things, including pursuit of a degree or other recognized education credential (need not be at a four-year college — think cosmetologist or auto technician); and enrollment for at least one academic period, at least on a one-half time basis (defined by the institution). There are other requirements, and you can find them on the IRS.gov website by typing student eligibility on the search bar.

To claim the AOTC, the taxpayer MUST have a Form 1098-T, tuition statement, issued by the education institution. That statement assists the taxpayer in computing the AOTC. There are certain AGI phase-outs, where the AOTC begins to become inapplicable; and the most common one is the $160,000-$180,000 AGI level for married couples. Even if you pay the tuition and other qualifying expenses via student loan proceeds, you can still claim the AOTC. It doesn’t matter whether the loan is in the name of the dependent child or in the name of the parent.

However, if the tuition or other expenses are paid with distributions from a 529 program, then the parents/taxpayers may not “double-dip.” In other words, if all expenses are covered with distributions from 529 programs, then there is no opportunity to claim the AOTC. Care must be exercised to use the 529 distributions for room and board expenses, and tuition and other costs, less $4,000 to maximize the potential for claiming the AOTC on the parents’ tax return for four years.

If you have navigated all these deductions, credits, etc., you are close to exiting the maze. But your head might continue spinning until graduation day, 2021.

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