The economic impact of the novel coronavirus (COVID-19) is unprecedented and many taxpayers with student loans have been hard hit.
The Coronavirus Aid, Relief and Economic Security (CARES) Act contains some assistance to borrowers with federal student loans. Notably, federal loans were automatically placed in an administrative forbearance, which allows borrowers to temporarily stop making monthly payments. This payment suspension is scheduled to last until September 30, 2020.
Tax deduction rules
Despite the suspension, borrowers can still make payments if they choose. And borrowers in good standing made payments earlier in the year and will likely make them later in 2020. So can you deduct the student loan interest on your tax return?
The answer is yes, depending on your income and subject to certain limits. The maximum amount of student loan interest you can deduct each year is $2,500. The deduction is phased out if your adjusted gross income (AGI) exceeds certain levels.
For 2020, the deduction is phased out for taxpayers who are married filing jointly with AGI between $140,000 and $170,000 ($70,000 and $85,000 for single filers). The deduction is unavailable for taxpayers with AGI of $170,000 ($85,000 for single filers) or more. Married taxpayers must file jointly to claim the deduction.
The interest must be for a “qualified education loan,” which means debt incurred to pay tuition, room and board, and related expenses to attend a post-high school educational institution. Certain vocational schools and post-graduate programs also may qualify.
The interest must be on funds borrowed to cover qualified education costs of the taxpayer, his or her spouse or a dependent. The student must be a degree candidate carrying at least half the normal full-time workload. Also, the education expenses must be paid or incurred within a reasonable time before or after the loan is taken out.
It doesn’t matter when the loan was taken out or whether interest payments made in earlier years on the loan were deductible or not. And no deduction is allowed to a taxpayer who can be claimed as a dependent on another taxpayer’s return.
The deduction is taken “above the line.” In other words, it’s subtracted from gross income to determine AGI. Thus, it’s available even to taxpayers who don’t itemize deductions.
Taxpayers should keep records to verify eligible expenses. Documenting tuition isn’t likely to pose a problem. However, take care to document other qualifying expenditures for items such as books, equipment, fees, and transportation. Documenting room and board expenses should be simple if a student lives in a dormitory. Student who live off campus should maintain records of room and board expenses, especially when there are complicating factors such as roommates.
Contact us if you have questions about deducting student loan interest or for information on other tax breaks related to paying for college.
© 2020 Covenant CPA
We all know the cost of college is expensive. The latest figures from the College Board show that the average annual cost of tuition and fees was $10,230 for in-state students at public four-year universities — and $35,830 for students at private not-for-profit four-year institutions. These amounts don’t include room and board, books, supplies, transportation and other expenses that a student may incur.
Two tax credits
Fortunately, the federal government offers two sizable tax credits for higher education costs that you may be able to claim:
1. The American Opportunity credit. This tax break generally provides the biggest benefit to most taxpayers. The American Opportunity credit provides a maximum benefit of $2,500. That is, you may qualify for a credit equal to 100% of the first $2,000 of expenses for the year and 25% of the next $2,000 of expenses. It applies only to the first four years of postsecondary education and is available only to students who attend at least half time.
Basically, tuition, course materials and fees qualify for this credit. The credit is per eligible student and is subject to phaseouts based on modified adjusted gross income (MAGI). For 2019, the MAGI phaseout ranges are:
- Between $80,000 and $90,000 for unmarried individuals, and
- Between $160,000 and $180,000 for married joint filers.
2. The Lifetime Learning credit. This credit equals 20% of qualified education expenses for up to $2,000 per tax return. There are fewer restrictions to qualify for this credit than for the American Opportunity credit.
The Lifetime Learning credit can be applied to education beyond the first four years, and qualifying students may attend school less than half time. The student doesn’t even need to be part of a degree program. So, the credit works well for graduate studies and part-time students who take a qualifying course at a local college to improve job skills. It applies to tuition, fees and materials.
It’s also subject to phaseouts based on MAGI, however. For 2019, the MAGI phaseout ranges are:
- Between $58,000 and $68,000 for unmarried individuals, and
- Between $116,000 and $136,000 for married joint filers.
Note: You can’t claim either the American Opportunity Credit or the Lifetime Learning Credit for the same student or for the same expense in the same year.
Credit for what you’ve paid
So which higher education tax credit is right for you? A number of factors need to be reviewed before determining the answer to that question. Contact us for more information about how to take advantage of tax-favored ways to save or pay for college.
© 2019 Covenant CPA
If you’re putting aside money for college or other educational expenses, consider a tax-advantaged 529 savings plan. Also known as “college savings plans,” 529 plans were expanded by the Tax Cuts and Jobs Act (TCJA) to cover elementary and secondary school expenses as well. And while these plans are best known as an educational funding vehicle, they also offer estate planning benefits.
What do 529 plans cover?
529 plans allow you to contribute a substantial amount of cash (lifetime contribution limits can reach as high as $350,000 or more, depending on the plan) to a tax-advantaged investment account. Like a Roth IRA, contributions are nondeductible, but funds grow tax-deferred and earnings may be withdrawn tax-free provided they’re used for “qualified education expenses.”
Qualified expenses include tuition, fees, books, supplies, equipment, room and board and, under the TCJA, up to $10,000 per year in elementary or secondary school expenses. Earnings used for other purposes are subject to income tax and a 10% penalty.
What are the estate planning benefits?
These plans are unique among estate planning vehicles. Ordinarily, to shield assets from estate taxes, you must permanently relinquish all control over them. But contributions to a 529 plan are considered “completed gifts” — which means the assets are removed from your taxable estate, together with all future earnings on those assets — even though you retain considerable control over the money. For example, unlike most other estate planning vehicles, you can control the timing of distributions, change beneficiaries, move the funds into another 529 plan, or even cancel the plan and get your money back (subject to taxes and penalties).
As a completed gift, a 529 plan contribution is eligible for the annual gift tax exclusion (currently $15,000). But unlike other vehicles, you can bunch up to five years’ worth of annual exclusions into one year. This allows you to contribute up to $75,000 in one year, without triggering gift or generation-skipping transfer (GST) taxes and without using up any of your lifetime exemption. There are implications, however, if you don’t survive the five years.
Why does it matter?
You might think that these benefits are of little value now that the TCJA has temporarily doubled the lifetime gift and estate tax exemption to an inflation-adjusted $10 million ($20 million for married couples who design their estate plans properly). This year, the exemption amount is $11.4 million ($22.8 million for married couples).
After all, few families are currently affected by these taxes. But it’s still a good idea to shield wealth from potential estate taxes and to make the most of your annual exclusion. This is because the new exemptions are scheduled to return to their previous levels after 2025 and there’s nothing to stop lawmakers from reducing the exemption in the future. 529 plans and other traditional estate planning tools provide some insurance against future estate tax changes.
Contact us to learn more about how a 529 plan can help achieve your estate planning and education goals.
© 2019 Covenant CPA
Years ago, Congress enacted the “kiddie tax” rules to prevent parents and grandparents in high tax brackets from shifting income (especially from investments) to children in lower tax brackets. And while the tax caused some families pain in the past, it has gotten worse today. That’s because the Tax Cuts and Jobs Act (TCJA) made changes to the kiddie tax by revising the tax rate structure.
History of the tax
The kiddie tax used to apply only to children under age 14 — which provided families with plenty of opportunity to enjoy significant tax savings from income shifting. In 2006, the tax was expanded to children under age 18. And since 2008, the kiddie tax has generally applied to children under age 19 and to full-time students under age 24 (unless the students provide more than half of their own support from earned income).
What about the kiddie tax rate? Before the TCJA, for children subject to the kiddie tax, any unearned income beyond a certain amount was taxed at their parents’ marginal rate (assuming it was higher), rather than their own rate, which was likely lower.
Rate is increased
The TCJA doesn’t further expand who’s subject to the kiddie tax. But it has effectively increased the kiddie tax rate in many cases.
For 2018–2025, a child’s unearned income beyond the threshold ($2,200 for 2019) will be taxed according to the tax brackets used for trusts and estates. For ordinary income (such as interest and short-term capital gains), trusts and estates are taxed at the highest marginal rate of 37% once 2019 taxable income exceeds $12,750. In contrast, for a married couple filing jointly, the highest rate doesn’t kick in until their 2019 taxable income tops $612,350.
Similarly, the 15% long-term capital gains rate begins to take effect at $78,750 for joint filers in 2019 but at only $2,650 for trusts and estates. And the 20% rate kicks in at $488,850 and $12,950, respectively.
That means that, in many cases, children’s unearned income will be taxed at higher rates than their parents’ income. As a result, income shifting to children subject to the kiddie tax won’t save tax, but it could actually increase a family’s overall tax liability.
Note: For purposes of the kiddie tax, the term “unearned income” refers to income other than wages, salaries and similar amounts. Examples of unearned income include capital gains, dividends and interest. Earned income from a job or self-employment isn’t subject to kiddie tax.
Gold Star families hurt
One unfortunate consequence of the TCJA kiddie tax change is that some children in Gold Star military families, whose parents were killed in the line of duty, are being assessed the kiddie tax on certain survivor benefits from the Defense Department. In some cases, this has more than tripled their tax bills because the law treats their benefits as unearned income. The U.S. Senate has passed a bill that would treat survivor benefits as earned income but a companion bill in the U.S. House of Representatives is currently stalled.
To avoid inadvertently increasing your family’s taxes, be sure to consider the kiddie tax before transferring income-producing or highly appreciated assets to a child or grandchild who’s a minor or college student. If you’d like to shift income and you have adult children or grandchildren no longer subject to the kiddie tax but in a lower tax bracket, consider transferring assets to them. If your child or grandchild has significant unearned income, contact us to identify possible strategies that will help reduce the kiddie tax for 2019 and later years
© 2019 Covenant CPA
The staggering cost of college makes it critical for families to plan carefully for this major expense, and in many cases grandparents want to play a role. As you examine the many financing options for your grandchildren, be sure to consider their impact on your estate plan.
Make direct payments
A simple, but effective, technique is to make tuition payments on behalf of your grandchild. So long as you make the payments directly to the college, they avoid gift and generation-skipping transfer (GST) tax without using up any of your $11.4 million gift or GST tax exemptions or your $15,000 annual gift tax exclusion.
A disadvantage of direct payments is that, if your grandchild is young, you have to wait until the student has tuition bills to pay. So there’s a risk that you’ll die before the funds are removed from your estate.
Draft a grantor trust
Trusts offer several important benefits. For example, a trust can be established for one grandchild or for multiple beneficiaries, and assets contributed to one, together with future appreciation, are removed from your taxable estate. In addition, the funds can be used for college expenses or for other purposes. Also, if the trust is structured as a “grantor trust” for income tax purposes, its income will be taxable to you, allowing the assets to grow tax-free for the benefit of the beneficiaries.
On the downside, for financial aid purposes a trust is considered the child’s asset, potentially reducing or eliminating the amount of aid available to him or her. So keep this in mind if your grandchild is hoping to qualify for financial aid.
Explore all of your options
Other college financing options include Sec. 529 college savings and prepaid tuition plans, savings bonds, retirement plan loans, Coverdell Education Savings Accounts, and various other tax-advantaged accounts. If you’d like to learn more about your options to help fund your grandchild’s education expenses, please contact us at 205-345-9898 or firstname.lastname@example.org.
© 2019 CovenantCPA
If you’re the parent of a child who is age 17 to 23, and you pay all (or most) of his or her expenses, you may be surprised to learn you’re not eligible for the child tax credit. But there’s a dependent tax credit that may be available to you. It’s not as valuable as the child tax credit, but when you’re saving for college or paying tuition, every dollar counts!
Background of the credits
The Tax Cuts and Jobs Act (TCJA) increased the child credit to $2,000 per qualifying child under the age of 17. The law also substantially increased the phaseout income thresholds for the credit so more people qualify for it. Unfortunately, the TCJA eliminated dependency exemptions for older children for 2018 through 2025. But the TCJA established a new $500 tax credit for dependents who aren’t under-age-17 children who qualify for the child tax credit. However, these individuals must pass certain tests to be classified as dependents.
A qualifying dependent for purposes of the $500 credit includes:
- A dependent child who lives with you for over half the year and is over age 16 and up to age 23 if he or she is a student, and
- Other nonchild dependent relatives (such as a grandchild, sibling, father, mother, grandfather, grandmother and other relatives).
To be eligible for the $500 credit, you must provide over half of the person’s support for the year and he or she must be a U.S. citizen, U.S. national or U.S. resident.
Both the child tax credit and the dependent credit begin to phase out at $200,000 of modified adjusted gross income ($400,000 for married joint filers).
The child’s income
After the TCJA passed, it was unclear if your child would qualify you for the $500 credit if he or she had any gross income for the year. Fortunately, IRS Notice 2018-70 favorably resolved the income question. According to the guidance, a dependent will pass the income test for the 2018 tax year if he or she has gross income of $4,150 or less. (The $4,150 amount will be adjusted for inflation in future years.)
More spending money
Although $500 per child doesn’t cover much for today’s college student, it can help with books, clothing, software and other needs. Contact us with questions about whether you qualify for either the child or the dependent tax credits. 205-354-9898 or email@example.com.
© 2019 CovenantCPA
If your son or daughter currently is home from college on winter break, now is a good time to sit down and discuss a few estate planning documents he or she should have at this stage of life. Let’s take a closer look at four such documents:
1. Health care power of attorney. With a health care power of attorney (sometimes referred to as a “health care proxy” or “durable medical power of attorney”), your child appoints someone — probably you or his or her other parent — to make health care decisions on his or her behalf should he or she be unable to do so. A health care power of attorney should provide guidance on how to make health care decisions. Although it’s impossible to anticipate every potential scenario, the document can provide guiding principles.
2. HIPAA authorization. To accompany the health care power of attorney, Health Insurance Portability and Accountability Act (HIPAA) authorization gives health care providers the ability to share information about your child’s medical condition with you. Absent a HIPAA authorization, making health care decisions could be more difficult.
3. Financial power of attorney. A financial power of attorney appoints someone to make financial decisions or execute transactions on your child’s behalf under certain circumstances. For example, a power of attorney might authorize you to handle your child’s financial affairs while he or she is out of the country studying abroad or, in the case of a “durable” power of attorney, incapacitated.
4. Will. Although your child is still in his or her upper teens or early twenties and probably doesn’t have too many assets, he or she isn’t too young to have a will drawn up. A will is a legal document that arranges for the distribution of property after a person dies. It names an executor or personal representative who’ll be responsible for overseeing the estate as it goes through probate.
If you have questions about any of these documents, don’t hesitate to give us a call at 205-345-9898. We can help provide peace of mind that your child’s health and financial affairs will be properly handled should the unthinkable happen.
© 2018 Covenant CPA
Section 529 plans are a popular education-funding tool because of tax and other benefits. Two types are available: 1) prepaid tuition plans, and 2) savings plans. And one of these plans got even better under the Tax Cuts and Jobs Act (TCJA).
Enjoy valuable benefits
529 plans provide a tax-advantaged way to help pay for qualifying education expenses. First and foremost, although contributions aren’t deductible for federal purposes, plan assets can grow tax-deferred. In addition, some states offer tax incentives for contributing in the form of deductions or credits.
But that’s not all. 529 plans also usually offer high contribution limits. And there are no income limits for contributing.
Lock in current tuition rates
With a 529 prepaid tuition plan, if your contract is for four years of tuition, tuition is guaranteed regardless of its cost at the time the beneficiary actually attends the school. This can provide substantial savings if you invest when the child is still very young.
One downside is that there’s uncertainty in how benefits will be applied if the beneficiary attends a different school. Another is that the plan doesn’t cover costs other than tuition, such as room and board.
Fund more than just college tuition
A 529 savings plan can be used to pay a student’s expenses at most postsecondary educational institutions. Distributions used to pay qualified expenses (such as tuition, mandatory fees, books, supplies, computer equipment, software, Internet service and, generally, room and board) are income-tax-free for federal purposes and typically for state purposes as well, thus making the tax deferral a permanent savings.
In addition, the Tax Cuts and Jobs Act expands the definition of qualified expenses to generally include elementary and secondary school tuition. However, tax-free distributions used for such tuition are limited to $10,000 per year.
The biggest downside may be that you don’t have direct control over investment decisions; you’re limited to the options the plan offers. Additionally, for funds already in the plan, you can make changes to your investment options only twice during the year or when you change beneficiaries.
But each time you make a contribution to a 529 savings plan, you can select a different option for that contribution, regardless of how many times you contribute throughout the year. And every 12 months you can make a tax-free rollover to a different 529 plan for the same child.
Picking your plan
Both prepaid tuition plans and savings plans offer attractive benefits. We can help you determine which one is a better fit for you or explore other tax-advantaged education-funding options. Contact us at 205-345-9898.
© 2018 Covenant CPA
If you’ve worked a lifetime to build a large estate, you undoubtedly would like to leave a lasting legacy to your children and future generations. Educating your children about saving, investing and other money management skills can help keep your legacy alive.
There’s no one right way to teach your children about money. The best way depends on your circumstances, their personalities and your comfort level.
If your kids are old enough, consider sending them to a money management class. For younger children, you might start by simply giving them an allowance in exchange for doing household chores. This helps teach them the value of work. Opening a savings account or a CD, or buying bonds, can help teach kids about investing and the power of compounding.
For families that are charitably inclined, a private foundation may be a great vehicle for teaching children about the joys of giving and the impact that wealth can make beyond one’s family. For this strategy to be effective, older children should have some input into the foundation’s activities. When the time comes, this can also be a great way to get your grandchildren involved at a young age.
Timing and amount of distributions
Many parents take an all-or-nothing approach when it comes to the timing and amounts of distributions to their children — either transferring substantial amounts of wealth all at once or making gifts that are too small to provide meaningful lessons.
Consider making distributions large enough so that your kids have something significant to lose, but not so large that their entire inheritance is at risk.
Introduce incentives, but remain flexible
An incentive trust is a trust that rewards children for doing things that they might not otherwise do. Such a trust can be an effective estate planning tool, but there’s a fine line between encouraging positive behavior and controlling your children’s life choices. A trust that’s too restrictive may incite rebellion or invite lawsuits.
Incentives can be valuable, however, if the trust is flexible enough to allow a child to chart his or her own course. A so-called “principle trust,” for example, gives the trustee discretion to make distributions based on certain guiding principles or values without limiting beneficiaries to narrowly defined goals. But no matter how carefully designed, an incentive trust won’t teach your children critical money skills.
Communication is key
To maintain family harmony when leaving a large portion of your estate to your children, clearly communicate the reason for your decisions. Contact us for more information at 205-345-9898.
© 2018 Covenant CPA