Paying for college may now be less taxing

The HOPE credit is available for certain tuition and fees, and it allows you to reduce taxes annually up to $1,500 per student for the first two years of college. The credit is equal to 100% of the first $1,000 of qualified expenses and 50% of the next $1,000.

The lifetime learning credit covers any year of post-secondary education and gives you a 20% tax credit on up to $5,000 in tuition and fees. The maximum credit is $1,000, no matter how many students in the family are eligible.

Both the Hope and lifetime learning credits start phasing out for married taxpayers filing jointly with adjusted gross income (AGI) of $82,000 and for single taxpayers with AGI of $41,000. Married taxpayers filing separate returns are not eligible for these credits.


Other education tax incentives

Education savings accounts. You may establish an education savings account (previously called an education IRA) with a nondeductible contribution for any child under 18. The annual contribution limit is $2,000. Funds can accumulate and be paid out tax-free for qualified college expenses, including tuition, fees, books, supplies, equipment, and certain room and board costs. The funds can also be used to pay for elementary and secondary (K-12) school expenses at public, private, or religious schools. Eligibility for an education IRA starts phasing out at $95,000 of AGI for single taxpayers and $190,000 for marrieds.

Individual retirement accounts (IRAs). Existing IRAs can also be a source of college funds. You may make withdrawals before age 59 1/2 without penalty for amounts paid for college or graduate school tuition, fees, books, room and board, supplies, and equipment.

Education savings bonds. Interest on Series EE and Series I bonds issued after 1989 is nontaxable when used to pay tuition and fees for you or your dependents. This tax break begins to phase out once income reaches certain levels.

Section 529 plans allow individuals to set up an account on behalf of someone else (say a child or grandchild) that can be used to pay college expenses. There are two types of plans:

Prepaid tuition plans are designed to hedge against inflation. You can purchase tuition credits, at today's rates, that your child can redeem when he or she attends one of the plan's eligible colleges or universities.

College savings plans are savings accounts that allow you to build a fund to pay for your child's college education. The funds can be used to pay tuition, fees, supplies, equipment, and certain room and board expenses.

Your contribution is not tax-deductible, but your investment can grow tax-deferred for as long as money stays in the plan. Qualified distributions from state-run plans are tax-free. This tax-free status extends to nonstate plans after 2003.

College expense deduction. For the years 2002 through 2005, there is an "above-the-line" deduction for qualified higher education expenses. The maximum deduction and the income limitations are as follows:

Student loan interest deduction. Interest on certain student loans can be deducted whether or not you itemize your deductions. The maximum deduction is $2,500 per year over the loan repayment period.

Other tax benefits. Most scholarships remain tax-free, nontaxable employer-paid tuition may be available, and education expenses related to your job still may be deductible.

When you start examining your situation, remember that many of these provisions are designed so that you can't benefit from more than one in any given year. We can help guide you through the maze and help ensure that you receive the maximum possible benefit.