The Tax Cuts and Jobs Act (TCJA) included many changes that affect individual taxpayers. But education-related tax breaks were left mostly untouched. The new law expanded one break, eliminated another, and left the rest alone. This is the second installment of our two-part story on education breaks after the TCJA. This one covers some breaks that changed. For Part 1 of the saga, see last week’s Tax Guy column.
Claim deduction for student loan interestYou can claim an above-the-line deduction for interest on education loans. Above-the-line means you need not itemize to benefit. The maximum annual write-off is $2,500.
To qualify for the interest deduction, the debt must be incurred within a reasonable time before or after eligible higher education expenses are incurred. Eligible expenses are defined as tuition, fees, room and board, and related expenses such as books and supplies for the taxpayer, spouse, or any dependent of the taxpayer to attend an eligible educational institution. The deduction is only allowed for expenses attributable to a year during which the student carries, for at least one academic period beginning in that year, at least half of a full-time course load in a program that would ultimately result in an associate’s degree, bachelor’s degree, or some other recognized credential.
For 2018, the deduction is phased out for unmarried taxpayers between modified AGI (MAGI) of $65,000 and $80,000. For joint filers, the phase-out range is between MAGI of $135,000 and $165,000. MAGI means “regular AGI” from the last line on page 1 of your Form 1040 increased by the deduction for tuition and fees (in years when it is allowed), the domestic production deduction (unlikely to be on your return), and certain tax-exempt income from outside the U.S. (also unlikely).
Married individuals who file separate returns are ineligible.
Take advantage of 529 plan liberalizationThe No. 1 best thing about 529 plan accounts is that you can take federal-income-tax-free distributions to cover qualified education expenses incurred for the account beneficiary. The second best thing is that our beloved Internal Revenue Code does not place any limits on the size of contributions to 529 accounts or any income limits on the tax-free distribution privilege. Even billionaires can partake.
The TCJA makes 529 plans even more appealing by allowing federal-income-tax-free withdrawals of up to $10,000 per year to cover tuition at a public, private, or religious elementary or secondary school. This change is permanent, for qualifying withdrawals taken after 12/31/17. However since 529 plans are operated by the states, some plans may choose to ignore or water down this change by not allowing distributions to cover tuition to attend religious elementary or secondary schools or by imposing state income tax on such distributions.
Another TCJA change benefits folks who want to make a really large lump-sum contribution to jump start a 529 account. For 2018, if you contribute more than $75,000 (or $150,000 if you are married and make a joint contribution with your spouse), it will use up part of your unified federal gift and estate tax exemption. However this is now of little concern, because the TCJA increased the exemption to a whopping $11.18 million if you’re single, or, effectively, an even-more-whopping $22.36 million if you’re married.
Contribute to Coverdell Education Savings Account (CESA)You can set up a CESA to pay qualified education expenses of the account beneficiary. You can then make contributions of up to $2,000 per year for each beneficiary. Contributions are nondeductible, but earnings accumulate federal-income-tax-free. Tax-free withdrawals can be taken to pay for the beneficiary’s postsecondary tuition, fees, books, supplies, and room and board.
The downside: your ability to contribute is phased out between MAGI of $95,000 to $110,000 for singles and $190,000 to $220,000 for married filing joint status. MAGI means “regular AGI” from the last line on page 1 of your Form 1040 increased by certain tax-exempt income from outside the U.S. that you are unlikely to have. If the parents’ MAGI is too high to allow a contribution, any other person can contribute to the account. For example, your child’s grandparents could make contributions. If you have several children (or grandchildren), you can set up separate CESAs for them and contribute up to $2,000 annually to each account (or somebody else can do that).
Taxpayers can also take tax-free CESA payouts to cover elementary and secondary school (K-12) costs. Under this privilege, eligible expenses include tuition and fees to attend private and religious schools plus room and board, uniform, and transportation costs. Taxpayers can also withdraw CESA money tax-free to pay out-of-pocket costs to attend public K-12 schools. Eligible expenses include books and supplies; academic tutoring; computers, peripheral equipment, and software; and even Internet access charges.
Starting contributions at an early date is really important if you want to take full advantage of the CESA break, because you generally cannot make any contributions after the account beneficiary reaches age 18.
You have until April 15 of the following year (adjusted for weekends and holidays) to make your annual CESA contribution for the current year. For example, you have until 4/15/19 to make a contribution for the 2018 tax year.
TCJA eliminates employee deductions for job-related education costsFor 2018–2025, the TCJA eliminates itemized deductions for miscellaneous expenses that were previously subject to the 2%-of-adjusted-gross-income (AGI) deduction threshold. Because most folks did not have enough miscellaneous expenses to exceed the 2%-of-AGI threshold, this now-disallowed write-off never got much attention. But it was an important tax benefit if you were an employee who wanted to deduct work-related education expenses that your company did not cover. You could generally claim deductions if the education maintained or improved skills used in your current job or profession. For example, the cost to obtain an MBA degree would often qualify. But for 2015-2025, employee deductions for work-related education expenses are off the books. Sorry about that! The TCJA giveth, and it taketh away.
If You Are Self-Employed: If you are self-employed as a sole proprietor, partner, or LLC member, you can still deduct education expenses that are related to your current business on your business tax form (Schedule C for sole proprietors, Schedule E for partners and rental property owners, or Schedule F for farmers and ranchers). You don’t have to worry about the TCJA’s elimination of deductions for work-related education expenses incurred by employees. However, you cannot deduct the cost of education that prepares you for a new job, business, or profession.
The bottom lineThe issue of tax breaks for education expenses is confusing. There are multiple breaks with multiple sets of rules, and several different breaks can potentially be available for the same expenses. Hopefully this column and the earlier one will help clarify matters. Politicians often talk about streamlining the education tax breaks, but it hasn’t happened so far. It would be a welcome development.
