Article Highlights:

  • Sec. 529 plans
  • Coverdell Education Savings Accounts
  • The Lifetime Learning credit
  • Qualified Education Loan Interest

Some in Congress have proposed “free” (i.e., government-paid) tuition for community college attendance. Even if that proposal were to become law, it still leaves parents and their children-students responsible for paying for college and university attendance if the student wants a bachelor or other degree. Over the years, Congress has provided a variety of tax incentives to help defray the cost of education. Some tax-related education benefits are currently available while others will be beneficial only with long-range planning, and the sooner these plans are implemented, the better.

Education Savings Plans – If your children are below college age, there are tax-advantaged plans that allow you to save for the costs of their higher education. While no tax deduction is allowed for contributions to the plans, they do provide tax-free accumulation of earnings; so, the earlier they are established, the more benefit you’ll get from them.

  • Section 529 Plans—Section 529 Plans (named after the section of the IRS Code that created them) are plans established to help families save and pay for education expenses in a tax-advantaged way and are available to everyone, regardless of income. These state-sponsored plans allow you to gift large sums of money for a family member’s college education while maintaining control of the funds. The earnings from these accounts grow tax-deferred and are tax-free, if used to pay for qualified higher education expenses. They can be used as an estate-planning tool as well, providing a means to transfer large amounts of money without gift tax. With all these tax benefits, 529 Plans are an excellent vehicle for college funding. Section 529 Plans come in two types, allowing you to either save funds in a tax-free account to be used later for higher education costs, or to prepay tuition for qualified universities. For 2022, you can contribute $16,000 without gift tax implications (or $32,000 for married couples who agree to split their gift). The annual amount is subject to inflation-adjustment. There is also a special gift provision allowing the donor to prepay five years of Sec 529 gifts up front without gift tax.The original intent of Section 529 Plans was to help taxpayers accumulate funds for college and university expenses. However, in recent years Congress has expanded the definition of eligible expenses to include the following:
  • Elementary and Secondary School Tuition Expenses – The Tax Cuts and Jobs Act (2017) included a provision that treats withdrawals from 529 plans for elementary or secondary school (kindergarten through grade 12) tuition expenses as qualified expenses. However, the annual withdrawal for each beneficiary is limited to $10,000 (regardless of the number of 529 plans in the beneficiary’s name). This special $10,000 amount applies only for tuition (not books, supplies, room and board, etc.) paid to public, private or religious schools.But remember, the primary goal of these plans is amassing tax-deferred investment income, which then can be withdrawn tax-free to pay qualified education expenses. Using these funds too early will not achieve the desired goal of accumulating and compounding investment income. Thus, you should carefully consider whether to use the funds for elementary and secondary school education expenses or to wait and tap the account for post-secondary education, with the latter choice maximizing investment income.
  • Apprenticeship Expenses – The category of qualified expenses was expanded by the Secure Act to include fees, books, supplies, and equipment required to participate in registered apprenticeship programs certified by the Secretary of Labor under Sec 1 of the National Apprenticeship Act, effective for distributions made in years after 2018.
  • Repayment of Student Loans – Another Secure Act addition to qualified expenses is effective for distributions after 2018 from a 529 plan of up to $10,000–a lifetime limit–that may be used to pay the principal and interest on qualified higher education loans of the designated beneficiary or a sibling of the designated beneficiary. To prevent double-dipping, Sec 529 plan distributions used to pay interest on the education loan cannot be used for the above-the-line deduction for student loan interest (discussed later in this article).

Coverdell Education Savings Account—These accounts are actually education trusts that allow nondeductible contributions to be invested for a child’s education. Tax on earnings from these accounts is deferred until the funds are withdrawn, and if used for qualified education purposes, the entire withdrawal can be tax-free. Qualified use of these funds includes elementary and secondary education expenses in addition to post-secondary schools A total of $2,000 per year can be contributed (but is not deductible) for each beneficiary under the age of 18. The ability to contribute to these plans phases out when the modified adjusted gross income of the contributor is between $190,000 and $220,000 for married taxpayers filing jointly, and between $95,000 and $110,000 for all others.

Education Tax Credits—If you currently have a child or children attending college, there are two tax credits, the American Opportunity Credit (partially refundable) and the Lifetime Learning Credit (nonrefundable), that you may be able to take advantage of. Both are available for qualified post-secondary education expenses for a taxpayer, spouse, and eligible dependents. Both credits will reduce your tax liability dollar for dollar until the tax reaches zero.

  • The American Opportunity Credit (AOTC)—is a credit of up to $2,500 per student per year, covering the first four years of qualified post-secondary education. The credit is 100% of the first $2,000 of qualifying expenses plus 25% of the next $2,000 for a student attending college on at least a half-time basis. Forty percent of the American Opportunity credit is refundable (if the tax liability is reduced to zero). This credit phases out for joint filing taxpayers with modified adjusted gross income (MAGI) between $160,000 and $180,000, and between $80,000 and $90,000 for others (except no credit is allowed for those who file married separate returns).
  • The Lifetime Learning Credit—is a credit of up to 20% of the first $10,000 of qualifying higher education expenses. Unlike the American Opportunity Credit, which is on a per-student basis, this credit is per taxpayer. In addition to post-secondary education, the Lifetime Credit applies to any course of instruction at an eligible institution taken to acquire or improve job skills. The MAGI phaseout ranges are the same as those for the AOTC, and like the AOTC, the Lifetime Learning Credit is not allowed for taxpayers who file married separate returns.

Qualifying expenses for these credits are generally limited to tuition. However, if required for the enrollment or attendance of the student, activity fees and fees for course-related books, supplies, and equipment qualify, but for the Lifetime Learning Credit course materials and supplies are eligible only if purchased directly from the educational institution.

Qualified tuition and related expenses paid by a student would be treated as paid by the taxpayer if the student is a claimed dependent of the taxpayer. So even if you did not pay your dependent child’s tuition, if a third party (most typically a grandparent, but it could be anyone besides you or the dependent) makes a payment directly to an eligible educational institution for the student’s qualified tuition and related expenses, the student would be treated as having received the payment from the third party, and, in turn, having paid the qualified tuition and related expenses. And if the student is your dependent, you could be eligible to claim the credit.

Education Loan Interest—You can deduct qualified education loan interest of up to $2,500 per year in computing AGI. This is not limited to government student loans and this could include home equity loans, credit card debt, etc., if the debt was incurred solely to pay for qualified higher education expenses. For 2022, the student loan interest deduction phases out for married taxpayers with an AGI between $145,000 and $175,000 and for unmarried taxpayers between $70,000 and $85,000. These amounts are subject to annual inflation-adjustment. This deduction is not allowed for taxpayers who file married separate returns.

While it is possible that Congress may add more tax-related benefits for assisting parents and students to pay for higher education costs, you shouldn’t depend on their actions (or inactions).  You should consider starting the planning process as soon as possible, and you don’t overlook the credits and deductions available for the current students in your family. Please call this office if you would like assistance in planning for your children’s future education or would like more information about the education benefits available now.


If you have any questions about planning an education fund, please contact our office at (503) 224-5321. Isler Northwest LLC is a firm of business advisors and CPAs in Portland, Oregon. Our service goal at Isler Northwest is to earn our clients’ trust as their primary business and financial advisor.

Isler Northwest

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