It’s no big secret that more young people are turning to college as a means to further their education and career prospects. According to the U.S. Department of Education, enrollment at degree-granting postsecondary institutions increased approximately 17 percent from 2004 to 2014. In addition, for the 2014-2015 academic year, the average cost for undergraduate tuition, fees, room and board were estimated to be $16,188 for public institutions, $41,970 for private nonprofit institutions, and $23,372 at private for-profit intuitions (U.S. Department of Education, 2016). Given the rise in attendance and the high cost of attending a postsecondary institution, some families may question how they can financially assist younger generations in obtaining their postsecondary educational goals. Fortunately, there are tax-advantageous strategies that can be employed to help assist students with reaching these goals.
529 Savings Plans
529 saving plans are state or educational institution sponsored plans designed to assist families save for future college costs through tax-free growth, as long as the funds from the plan are used to pay for qualified education expenses at some point in the future. Many states also offer full or partial up-front tax breaks as well for amounts contributed to the plan. Based on current gift tax regulations, a taxpayer can contribute up to $14,000 per year per beneficiary to a 529 plan without gift tax repercussions. In addition, taxpayers can also make a contribution up to $70,000 in a single year and elect to treat the contribution as made over a five year period for gift tax purposes. In this scenario however, the filing of a gift tax return would be warranted. On major benefit of a 529 plan is that it allows the account owner (typically the person setting up the account) to retain control over the account, including the right to change the beneficiary on the account at a future date.
Another potential option includes a family member paying the tuition directly to a qualified postsecondary institution on behalf of an eligible student. In this scenario, as long as the payment is made directly to the institution, the amount paid is excluded for gift tax purposes. However, the payment can only include amounts for tuition and cannot be for room, board, books, supplies or other expenses. In addition, it is important to consider that by making a direct gift, it could potentially reduce the amount of need-based financial aid the student is eligible to receive.
Educational trusts are generally setup with the primary goal of assisting younger generations with the funding of their postsecondary education. Depending on your goals, there are certain types of trusts which may benefit you and the student more. In general, the trust grantor (individual setting up and funding the trust) can decide to fund the trust immediately or upon their death. The grantor can also usually dictate specific terms of the trust, such as naming the trustee and beneficiaries, specifying how the funds are to be used and determining how the trust terminates. Generally, educational trusts are more advantageous in situations where there is a significant amount of money that can be set aside for educational purposes. In addition, an attorney will need to draft the necessary documents to establish the trust. Although educational trust can involve additional expenses and lack certain tax benefits that other alternatives may provide, educational trusts can be useful to minimize estate taxes and allow for increased control of fund assets, all while assisting with the educational needs of younger generations.
One of the more commonly used educational tax saving opportunities involves claiming a credit for amounts paid to qualified educational expenses. There are currently two credits available to taxpayers for educational purposes, the American Opportunity Credit and the Lifetime Learning Credit. The American Opportunity Credit allows for a maximum $2,500 credit for at least half time students pursuing a post-secondary education during their first four years of college. The Lifetime Learning Credit allows for a maximum $2,000 credit and is available to anyone who attended at least one course during the taxable year for any year of study. Both credits are subject to an income phase out, however. For 2016, the American Opportunity Credit phased out for married filers from $160,000 to $180,000 ($80,000 to $90,000 for single taxpayers), while the Lifetime Learning Credit phased out from $110,000 to $130,000 for married taxpayers ($55,000 to $65,000 for single taxpayers).
Planning for the education of a family member can be a complex and confusing process. In addition to planning for education, it is important to consider possible changes to the regulations in coming years. Although President Trump and the Republican controlled Congress have not yet announced significant changes in regards to education tax planning ideas, it is not out of the realm of possibility that a change of that nature could occur now or in the future be a subsequent administration. If you have questions regarding these or any other education tax planning ideas, please feel free to contact a member of our Family Wealth Service team.
Derek is a manager on our tax team and member of the Firm’s Family Wealth team.. He specializes in assisting individual and corporate fiduciaries with complex trust/estate tax and compliance related issues. In addition, he excels in providing individuals and business owners with sound tax and business planning, taking into consideration their unique concerns and issues.