Here's some tax advice from the National Tax Advice Day web site on deducting college expenses from your income taxes:
The Economic Growth and Tax Relief Reconciliation Act of 2001 created a temporary tax deduction for college expenses. For 2005, the last year you can take advantage of this deduction, the maximum allowable deduction is $4,000. For persons earning more than $65,000 and not more than $80,000, the allowable deduction is cut in half to $2,000. (For married persons filing jointly, the respective limits are $130,000 and $160,000.)
Married persons filing a separate return are not eligible for the deduction. In addition, you cannot deduct those expenses that are claimed for the Hope credit or lifetime learning credit, or that have been paid for with distributions from a Section 529 Plan, education savings account, or savings bonds whose interest you deduct for paying college expenses.
The money that you invest in yours, your spouse's, or a dependent's higher education translates into direct tax savings. The tax deduction is an above-the-line deduction. This means you don't have to itemize or limit the deduction to amounts that exceed 2% of your AGI.
The following table calculates the tax savings and future value for two investors. One investor is in the 25% tax bracket for 2005. The other investor is in the 28% tax bracket. Both investors can earn a 5% rate of return. Future value is calculated for a five-year period for a taxable and tax-exempt account.
Value of $4,000 tax deduction for 25% and 28% tax brackets (2005):
Tax bracket: 25%
- Qualified expenses: $4,000
- Tax savings: $1,000
- Savings interest rate: 5%
- Future value (5 years): Tax-exempt account: $1,283
- Future value (5 years): Taxable account: $1,206
Tax bracket: 28%
- Qualified expenses: $4,000
- Tax savings: $1,120
- Savings interest rate: 5%
- Future value (5 years): Tax-exempt account: $1,437
- Future value (5 years): Taxable account: $1,341
If you are in the higher bracket, $4,000 in deductions saves you $1,120 in taxes this year. Invested in a tax-exempt account at 5% compounded yearly, this amount grows to $1,437. Invested in a taxable account at 5%, it grows to $1,341.
The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax adviser.
For tax-related questions, FMF recommends: H&R Block. Do it yourself or have us do it. It's never been easier.
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