While evaluating those college financial aid offers, be aware that there are more numbers to consider than the ones on the page. Tax consequences can both add to and subtract from your college aid.
On the negative side, scholarships, grants and fellowships can be taxable to the student if they exceed the qualified expenses outlined by the IRS.
With tuition, fees and books, you need a fairly large financial aid package to get over the limit. The most important thing to remember is room and board do not count as qualified expenses.
On the plus side, many taxpayers can take one of two tax credits or a tax deduction for tuition and fees paid for during the previous year.
But one question I had this year with a client was who takes the credit -- the student or the parent? You sometimes have to run an analysis to see which gives you the most tax savings.
Let's break down both sides of this taxing question.
According to IRS publication 970, "Tax Benefits for Education," if a student's financial aid -- generally a combination of school, state and federal grants and scholarships -- is greater than tuition, fees, books and other required course expenses, taxes are owed on the remainder of the aid. This includes aid such as institutional or private scholarships, federal Pell and Fulbright grants, the Texas grant and athletic scholarships.
Not included in this group are tuition reductions by the school, if the student teaches or does research for the school. Veterans education benefits (even if they include housing) are also not taxed, nor is attendance at the service academies, since attending is a job and cadets get tax withholding in their paychecks.
The big thing to remember is that nontuition-related expenses, like room and board, transportation and other typical living expenses not mentioned above, cannot be covered by financial aid that is tax-free.
Students will receive IRS Form 1098T from the school to show any scholarships or grants awarded by the school, she said. It's up to the student (or parent) to figure out whether any aid is taxable.
If the entire scholarship is excluded, you don't have to file. But the taxable portion of a scholarship is considered earned income.
The good news is that the student can still take a standard deduction, even if still listed as a dependent on parents' taxes. The 2011 standard deduction for a dependent on someone else's tax return is the greater of $950 or the student's earned income plus $300, up to $5,800.
That means the student can get up to $5,800 in taxable aid and still not have to pay tax on it.
For example, say a student gets $15,000 in scholarships and grants from the school, but tuition, fees and books come to only $10,000. That's $5,000 in taxable aid. But since the standard deduction can go as high as $5,800, there's no tax due.
Add on a summer or school job that paid $2,000, however, and total earned income is now $7,000. Subtract the standard deduction and that's $1,200 in taxable income. The lowest federal income tax rate is 10 percent, so that would mean $120 in tax owed.
I would definitely take whatever help is given in financial aid. Just be aware of the tax consequences.
Keeping track of financial aid for the academic year, which is typically split into two semesters spanning two tax years, can be a challenge. Just remember in your second, third and fourth years of school to consider your aid from the previous semester.
Also be sure to keep tuition and book receipts, just like any other tax-deductible items, in case the IRS challenges you.
When considering financial aid packages, another piece to include is the type Uncle Sam can give you in the form of tuition credits and deductions.
Last year, the American Opportunity credit was expanded to include up to four years of college for up to $2,500 in qualified college education expenses (tuition, fees and required books and supplies).
The credit, which was extended last year to go through 2012, is per student, and parents can qualify with income limits up to $90,000 for a single parent and $180,000 for married couples. One big advantage to the American Opportunity credit is that it is refundable up to 40 percent. This means that even if you don't owe taxes at the end of the year, you can get up to 40 percent of this credit given to you in the form of a tax refund.
A second credit that can be taken instead of the American Opportunity is the Lifetime Learning credit, which is less (up to $2,000) and is per return, meaning even if you have several members of your family in school, you can still only claim this credit once a year.
This credit is more flexible in that you do not have to be pursuing a degree to claim it and there are no limits on the number of years in school it can be used, making it a good choice for graduate students.
Income limits for the Lifetime Learning credit are $60,000 single and $120,000 married filing jointly.
Either credit should be considered in calculating your student's overall financial aid, if you fall under the income limits. While you will have to pay the tuition, fees and books it covers upfront, you could get a benefit from the credits come tax time.
Finally, tuition and fees can be deducted, although the deduction is not as much tax savings as the credit would create. To qualify for this deduction, your income has to be under $80,000 for a single filer and $160,000 for married filing jointly.
The deduction can take your income subject to tax down by as much as $4,000.
On the negative side, scholarships, grants and fellowships can be taxable to the student if they exceed the qualified expenses outlined by the IRS.
With tuition, fees and books, you need a fairly large financial aid package to get over the limit. The most important thing to remember is room and board do not count as qualified expenses.
On the plus side, many taxpayers can take one of two tax credits or a tax deduction for tuition and fees paid for during the previous year.
But one question I had this year with a client was who takes the credit -- the student or the parent? You sometimes have to run an analysis to see which gives you the most tax savings.
Let's break down both sides of this taxing question.
According to IRS publication 970, "Tax Benefits for Education," if a student's financial aid -- generally a combination of school, state and federal grants and scholarships -- is greater than tuition, fees, books and other required course expenses, taxes are owed on the remainder of the aid. This includes aid such as institutional or private scholarships, federal Pell and Fulbright grants, the Texas grant and athletic scholarships.
Not included in this group are tuition reductions by the school, if the student teaches or does research for the school. Veterans education benefits (even if they include housing) are also not taxed, nor is attendance at the service academies, since attending is a job and cadets get tax withholding in their paychecks.
The big thing to remember is that nontuition-related expenses, like room and board, transportation and other typical living expenses not mentioned above, cannot be covered by financial aid that is tax-free.
Students will receive IRS Form 1098T from the school to show any scholarships or grants awarded by the school, she said. It's up to the student (or parent) to figure out whether any aid is taxable.
If the entire scholarship is excluded, you don't have to file. But the taxable portion of a scholarship is considered earned income.
The good news is that the student can still take a standard deduction, even if still listed as a dependent on parents' taxes. The 2011 standard deduction for a dependent on someone else's tax return is the greater of $950 or the student's earned income plus $300, up to $5,800.
That means the student can get up to $5,800 in taxable aid and still not have to pay tax on it.
For example, say a student gets $15,000 in scholarships and grants from the school, but tuition, fees and books come to only $10,000. That's $5,000 in taxable aid. But since the standard deduction can go as high as $5,800, there's no tax due.
Add on a summer or school job that paid $2,000, however, and total earned income is now $7,000. Subtract the standard deduction and that's $1,200 in taxable income. The lowest federal income tax rate is 10 percent, so that would mean $120 in tax owed.
I would definitely take whatever help is given in financial aid. Just be aware of the tax consequences.
Keeping track of financial aid for the academic year, which is typically split into two semesters spanning two tax years, can be a challenge. Just remember in your second, third and fourth years of school to consider your aid from the previous semester.
Also be sure to keep tuition and book receipts, just like any other tax-deductible items, in case the IRS challenges you.
When considering financial aid packages, another piece to include is the type Uncle Sam can give you in the form of tuition credits and deductions.
Last year, the American Opportunity credit was expanded to include up to four years of college for up to $2,500 in qualified college education expenses (tuition, fees and required books and supplies).
The credit, which was extended last year to go through 2012, is per student, and parents can qualify with income limits up to $90,000 for a single parent and $180,000 for married couples. One big advantage to the American Opportunity credit is that it is refundable up to 40 percent. This means that even if you don't owe taxes at the end of the year, you can get up to 40 percent of this credit given to you in the form of a tax refund.
A second credit that can be taken instead of the American Opportunity is the Lifetime Learning credit, which is less (up to $2,000) and is per return, meaning even if you have several members of your family in school, you can still only claim this credit once a year.
This credit is more flexible in that you do not have to be pursuing a degree to claim it and there are no limits on the number of years in school it can be used, making it a good choice for graduate students.
Income limits for the Lifetime Learning credit are $60,000 single and $120,000 married filing jointly.
Either credit should be considered in calculating your student's overall financial aid, if you fall under the income limits. While you will have to pay the tuition, fees and books it covers upfront, you could get a benefit from the credits come tax time.
Finally, tuition and fees can be deducted, although the deduction is not as much tax savings as the credit would create. To qualify for this deduction, your income has to be under $80,000 for a single filer and $160,000 for married filing jointly.
The deduction can take your income subject to tax down by as much as $4,000.
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