Tips on Ways to Make the Most of Tax Credits
The following tips will help you get the greatest benefit from your tax breaks.
Coordinate contributions to a child's Education Savings Account with other family members since the per-year limit on contributions is per child not per contributor.
From 2002 to 2010, you may contribute to an Education Savings Account and a Qualified Tuition Program in the same year. Both contributions are gifts and may trigger gift tax if a total of more than the annual gift tax limit ($12,000 for 2006, indexed for inflation; $24,000 for a married couple splitting the gift) is contributed in one year for the same student.
Contributions to a qualified tuition program of up to $60,000 ($12,000 X 5, for 2006) can be made in one year but treated as made over up to 5 years, avoiding gift tax issues. Contributions to an Education Savings Account are not eligible for this treatment. Contributing to an Education Savings Account in the same year you make a contribution greater than the annual gift tax limit to a tuition program will reduce the amount of the tuition program contribution you can exclude from gift taxes for each of those five years.
Bunching tuition payments into one tax year may help you get the largest credit or deduction.
Different tax benefits have different requirements for qualified expenses. Match funds from different sources with the right type of college expenses.
Check to see if you must claim your child as a dependent to claim the tax credit.
Check to see if you can take proceeds from a home equity loan or credit line to pay tuition and still take a tax credit.
Part-time students are eligible for certain tax credits.
A Roth IRA may be an alternative to other savings mechanisms. Contributions can be taken out free of taxes or penalties at any time, and distributions are treated as coming first from contributions. Distributions of earnings will be taxed but will not be subject to the 10% penalty when used for higher education expenses.
Eligibility for some tax breaks may be lost if the wrong person pays the expense. Rules depend on the tax break and whether the student is a dependent. Check IRS Publication 970 for details and examples.
Money in the name of a child will affect financial aid more than money in the name of the parent. Education Savings Accounts and Qualified Tuition Plans are considered assets of the owner, typically the parent.
Delay withdrawing money from retirement IRAs or using other strategies that will increase your reportable income until late in the junior year or senior year, when it won't affect eligibility for financial aid.
If you must sell investments to pay for college, you may have heard the suggestion to first gift the investments to your child to sell at his (presumably) lower tax rate. As of 2006, unearned income over $1700 for any dependent up to the age of 18 is taxed at the parent’s rate, making the strategy less beneficial than in the past.
Until 2001 and possibly again beginning in 2011, taking a distribution from an Education Savings Account precluded you from claiming the Hope Scholarship Credit or the Lifetime Learning Credit.
