Financial Planning Blog

So much is going on with the economy and the government’s response to the financial crisis it’s hard to keep up. For those of you with children in college or about to start, you’ll want to pay attention to recent changes to the various federal tax benefits for education. Although these changes may not make up for recent losses in your 529 plans or retirement accounts, they will provide significant savings for some of you.

The American Recovery and Reinvestment Act of 2009 expanded the Hope Credit program in a couple of very important ways. First, for those of you unfamiliar with the Hope Credit, it is a sizeable tax credit for qualified tuition and related college expenses which can be taken by either the parents or student—whoever claims the student as an exemption on their tax return. In 2008, the credit was for 100% of the first $1,200 of qualified expenses, and 50% of the next $1,200, for a maximum amount credit of $1,800. The student was required to be in their first two years of college and enrolled at least half-time. Just to be clear, this is per student, so if you are lucky enough to have multiple children in the first two years of college, you can claim multiple credits. Unfortunately (or fortunately, depending on how you look at it), some of you are ineligible for the credit in 2008 because of the adjusted gross income phase-outs that start at $96,000 for married filing jointly, and $48,000 for others.

Fast forward to 2009, and a good deal gets a good deal better. First, the Hope credit has been raised to $2,500 (100% of first $2,000, and 25% of the next $2,000 of qualified expenses). Second, eligibility for the credit has been extended to four years, instead of only two. And, for those of you frustrated because you missed out in 2008 because of the AGI limitation, these have been made significantly higher also. Now the AGI phase-outs don’t start until you hit $160,000 for married filing jointly and $80,000 for single filers. As this isn’t enough, the credit is now 40% ($1,000) refundable, in order to allow low income students to take advantage.

These enhancements provide a little something for almost every family with a student in college. However, the expansion of these benefits is only for education expenses in 2009 and 2010, although there are proposals to make the changes permanent.

The Hope Credit’s less attractive sister, the lifetime learning tax credit, was not similarly expanded. At least for the next couple of years, the Hope Credit will be a much better deal for all students who are enrolled at least half-time. For part-time students (less than half-time) it is still worthwhile to check out the lifetime learning credit which provides a 20% credit on up to $10,000 of qualified expenses per household.

A few other caveats regarding the Hope Credit should be noted. Qualified expenses include mandatory fees and tuition, but not room and board. You cannot use the Hope Credit and lifetime learning tax credit, or the tax deduction for tuition and fees, for the same student in the same year. You cannot use the same qualifying expenses for the Hope Credit that you use for a tax free distribution from a 529 plan.

If you’re interested in more information on education tax benefits check out http://www.finaid.org/otheraid/tax.phtml
or IRS publication 970 (although this has yet to be updated for 2009).