Qualified State Tuition Programs
A qualified state tuition program is one generally set
up by a state or state instrumentality that lets individuals
make contributions to an account established for a designated
beneficiary's higher education.
Unlike the Coverdell Education
Savings Account, there is no limit on the annual contributions
to Qualified State
Tuition programs. However, contributions to these plans
are considered gifts to the beneficiary making the annual
$10,000 gift exclusion the practical annual limit per contributor.
A special rule allows a donor who makes total contributions
exceeding the annual gift limit to elect to take the contributions
into account ratably over a 5 year period, starting with
the year of the contribution. This allows a donor to contribute
as much as $50,000 in one year while avoiding the gift
tax implications. The donor must file a gift tax return
for the year of the contribution, and a 5-year election
must be made on the return. Care should be exercised in
determining the total contributed to any individual's account
to avoid nonqualified distributions if the amount
exceeds the educational needs.
Virtually all of the high population states now have these
programs which are professionally managed and tailor the
investments and risk potential to the potential student's
current age. Individuals are not restricted to using the
program established in their home state, but instead can
pick and choose among the programs of any the states that
have established programs.
The benefit of these programs was significantly enhanced
for years after 2003 when the distributions of earnings
from the programs can be excluded from income if used for
qualified expenses. This is a big change from prior rules
where the earnings from the accounts were taxable to the
beneficiary when withdrawn. This puts the Qualified State
Tuition Programs on par with Coverdell Education Savings
Accounts, but without the annual contribution limit. Additional
rules apply for designated beneficiaries, death of taxpayer
or beneficiary, and unauthorized use of distributions.
Penalty Free IRA Withdrawals
Generally, when funds are withdrawn from an IRA before
a taxpayer reaches age 59-1/2, a 10% early withdrawal penalty
applies to the distribution. For tax years beginning in
1998, penalty-free withdrawals will be permitted if the
funds are used to pay qualified higher education expenses.
The withdrawals will still be subject to regular income
tax.
Qualified "higher education expenses" include
tuition at a qualified educational institution, as well
as related room, board, fees, books, supplies and equipment.
The expenses can be for the taxpayer, spouse, taxpayer's
or spouse's children and grandchildren.
Deduction For Education
Loan Interest
Generally, taxpayers can only deduct home mortgage interest,
investment interest, and business interest However, interest
paid on student loans used to pay tuition, room and board,
and related expenses for qualified higher education is
even if the taxpayer uses the standard deduction. The amount
deductible was initially limited to $1,000 in 1998 and
has gradually increased so that up to $2,500 is deductible
in 2001 and after.
Caution: Home mortgage interest
can't be re-characterized
as education interest. Thus, home equity loan interest,
even if used to pay college costs, can be deducted only
if a taxpayer Itemizes deductions.
The deduction for student loan interest was initially
limited to the first 60 months in which payments are required.
However, beginning in 2002, that restriction has been removed.
The annual deduction begins to phase out when modified
AGI is between $50,000 and $65,000 ($40,000 and $50,000
for years prior to 2002) for single taxpayers and between
$80,000 and $150,000 (60,000 and $75,000 for years prior
to 2002) for joint return filers. The modified AGI levels
will be inflation adjusted after the year 2002.
return to Tax Breaks
for Higher Education
