School is back in session, so it’s a good time to update you on all the education-related federal income tax breaks. Some were changed by Tax Cuts and Jobs Act (TCJA) and the Bipartisan Budget Act of 2018 (Budget Act). Others stayed the same. Here’s the rundown.
Change No. 1: More tax-free distributions from 529 plans
The TCJA liberalizes the Section 529 plan rules to allow federal-income-tax-free withdrawals of up to $10,000 per year to cover tuition at public, private, or religious elementary or secondary schools (K-12). This change applies to eligible withdrawals taken after 12/31/17. However, because 529 plans are operated by the states, some blue and purple state plans may not adopt this change.
Change No. 2: Deduction for college tuition and fees (wait for it)
Our beloved Internal Revenue Code allows a limited above-the-line deduction for eligible tuition and fees. Above-the-line means you don’t have to itemize to benefit. Depending on your income, the maximum write-off is either $4,000 or $2,000 or nothing. This break expired at the end of 2016, but it was retroactively reinstated for 2017 by the Budget Act. For it to be available for this year, Congress will have to resurrect it again. I fully expect that to happen. Stay tuned to this column for developments.
Change No. 3: No more miscellaneous itemized deductions for employee unreimbursed work-related education expenses
For 2018-2025, the TCJA eliminates write-offs for miscellaneous itemized expenses that under prior law were subject to the 2%-of-adjusted-gross-income deduction threshold. Included in this category are unreimbursed employee business expenses. So for 2018-2025, an employee cannot claim miscellaneous itemized deductions for unreimbursed work-related education expenses.
This change is bad news for employees who want to go back to school to improve their business skills or resumes.
Change No. 4: Tax-free treatment for more forgiven student loans
The general rule is that the cancellation of a debt results in taxable income. Such income is often called COD income. Under an exception to the general rule, COD income from certain discharges of student loan debt is federal-income-tax-free, as long as the discharge is contingent on the student working for a certain period of time in certain professions for certain classes of employers.
The TCJA temporarily expands the tax-free COD income break to cover certain discharges of student loan debt on account of the student’s death or disability. Specifically, for qualifying partial or total debt discharges that occur in 2018-2025, any COD income triggered by the death or total and permanent disability of the student is federal-income-tax-free. To be eligible for this break, the forgiven debt must be a student loan as defined by the Internal Revenue Code or a private education loan as defined by the Consumer Credit Protection Act.
Education breaks that were not changed
Here’s the list of the most popular education-related breaks that were not changed by recent legislation. For these, it’s business as usual.
Working condition fringe benefits
An employer can reimburse an employee for certain job-related education expenses, and the reimbursements will be treated as tax-free working condition fringe benefit payments. In a nutshell, this favorable treatment is generally allowed if: (1) the education is required by your employer or by law or regulation in order for you to retain your current job or (2) the education maintains or improves skills required in your current job. Tax-free fringe benefit treatment also applies when your employer covers the cost of education that meets the preceding guidelines by making direct payments to the educational institution.
Educational assistance programs
Some lucky folks work at companies with educational assistance programs that can give each eligible employee up to $5,250 in annual federal-income-tax-free benefits. These plans are sometimes called Section 127 plans after the part of our beloved Internal Revenue Code that allows them. These plans can cover the cost of almost anything that constitutes legitimate education, including graduate coursework, whether the education is job-related or not. However, some Section 127 plans only reimburse for education that is job-related, which is understandable.
American Opportunity credit can cover up to $2,500 of undergraduate college degree costs
The American Opportunity tax credit equals 100% of the first $2,000 of eligible college expenses plus 25% of the next $2,000. So the maximum annual credit is $2,500. If you have more than one eligible student in the family, the credit can be claimed for each student. So the total credit can potentially be a pretty big number.
Needless to say, there are some limitations.
* The student must be enrolled in a post-secondary degree, certificate, or other program leading to a recognized post-secondary educational credential at an eligible educational institution.
* The credit cannot be claimed for the tax year if the student has already collected four years’ worth of college credit as of the beginning of that year.
* The credit for a particular student can only be claimed for four tax years.
* The student must carry at least half the normal full-time workload for the student’s course of study for at least one academic period that begins during the tax year.
* Finally, the credit is phased out (reduced or completely eliminated) if your modified adjusted gross income (MAGI) is too high. The phase-out range for unmarried individuals is between MAGI of $80,000 and $90,000. The range for married joint-filers is $160,000-$180,000.
MAGI means the AGI amount shown on the last line of Page 1 of your Form 1040 increased by certain tax-exempt income from outside the United States, which you probably don’t have.
Lifetime learning credit can cover up to $2,000 for grad school and other training
The Lifetime Learning credit equals 20% of up to $10,000 of eligible education expenses. This translates into a maximum annual credit of $2,000. Unlike the American Opportunity credit, there’s no limit on the number of years the Lifetime Learning credit can be claimed, nor are there any degree program or course load requirements.
So the Lifetime Learning credit can be used to help offset costs for undergraduate study that drags on for more than four years, or for undergraduate years when the student carries a light course load, or for graduate school courses, or for courses to improve job skills or maintain professional certifications, or for courses taken for just about any other reason.
* The maximum amount of annual expenses for which the credit can be claimed is limited to $10,000, regardless of how many students are in your family.
* Like the American Opportunity credit, the Lifetime Learning credit is also phased out if your modified adjusted gross income (MAGI) is too high. However, the phase-out ranges for the Lifetime Learning credit are at much lower levels. For 2018, the phase-out range for unmarried individuals is between MAGI of $57,000 and $67,000. The range for married joint-filers is $114,000-$134,000.
Deductions for work-related education costs incurred by self-employed individuals
You can deduct qualified education expenses as self-employed business expenses on Schedule C, E, or F of your Form 1040. Qualified expenses mean costs for training that meets one or both of the following standards.
Standard No. 1: The education is expressly required by applicable law or regulations in order for you to retain your current status (for example, as a CPA).
Standard No. 2: The education maintains or improves skills required in your current business or profession. You cannot deduct the cost of a program of study that trains you for a new business or profession as a self-employed business expense.
Key Point: While the IRS disagrees, the Courts have frequently allowed MBA costs to be deducted under Standard No. 2. However, the Courts agree with the IRS that undergraduate degree costs automatically prepare you for a new business profession. So you cannot deduct undergraduate degree costs as a self-employed business expense. However, you may be able to claim one of the credits or the tuition and fees deduction for those costs.
The bottom line
There you have it: the updated scoop on education-related tax breaks after the recent law changes. Here’s hoping that you can cash in.
