A Quick Study for Taxpayers

There are several tax breaks for education costs, but you best mind your P's and Q's in picking one.
By Tracy Byrnes ,

It costs a ton of money to send your kid to a keg party these days.

Whether he's whooping it up at a $45,000-a-year private school or your state's localcollege, the cost of admission to these parties is not cheap.

Uncle Sam understands, sort of. There are a few education tax credits and deductions availableto help defray the costs of your child's four years of bliss. And while they won't wipe out yourwhole tuition bill, you have to take what you can get.

There is one big thing to note, though: The only expenses that qualify for these credits and deductions arethe tuition and fees you need to pay for enrollment or attendance at any college, vocationalschool, or other postsecondary educational institution, says the IRS.

So you're on your own for room and board, books, and all the other expenses that your littledarling must pay to, uh, learn.

The Hope and Lifetime Learning Credits

The Hope Credit is a tax credit for college students in their first two years ofpostsecondary education, such as college or vocational school. The maximum credit is $1,500 onthe first $2,000 of tuition and fees.

This credit does not apply to graduate and professional-level programs and the student must beenrolled at least part-time to qualify.

The Lifetime Learning Credit, on the other hand, is for anyone who takes college classes. Soif you, your spouse, or your dependents are enrolled at an eligible educational institution andyou were responsible for paying the expenses, you can take this credit. And the upside here isthat the credit not only applies to undergraduate, but it will work for graduate and professionaldegree courses, too. Better yet, you don't need to be a part-time student. So if you decided to take one class at a local college to improve your current job skills, you could take advantage ofthis credit.

The maximum tax credit here is 20% on the first $10,000 of college tuition and fees, or$2,000.

There are income limitations, however, on both credits. The amount of these credits is phasedout, or slowly decreased, when your adjusted gross income, or AGI, hits $85,000 for people filing jointly(that's $42,000 for singles) and then eliminated completely when your AGI reaches $105,000($52,000 for singles).

Tuition and Fees Deduction

The tuition and fees deduction allows you to deduct up to $4,000 of the tuition bill you payfor any postsecondary school. Even better, the AGI limitations are higher.

For 2004, if your adjusted gross income doesn't exceed $130,000 as a married couple ($65,000if you're single), you can claim the full deduction of $4,000. If your AGI is greater than$130,000 ($65,000 for singles), but is not more than $160,000 ($80,000 single), your maximumtuition and fees deduction is $2,000. The deduction is gone once your AGI goes above $160,000(again, $80,000 for singles).

"This deduction is actually a bit better than the Hope or Lifetime Learning credit because atleast people in the higher income brackets get something," says Kathy Burlison, a tax specialistwith H&R Block.

Now for the bad news: This deduction is set to expire at the end of 2005 unless Congress decides toextend it.

Do Some Party Planning

So you have three options. You need to pick the Hope, Lifetime Learning credit or the tuitionand fees deduction, because there is only one perk per student.

Unfortunately, you have to understand some arcane tax rules to make some sound decisions. Here'sthe big issue: The Hope and Lifetime Learning credits are negated from your total tax bill.The tuition and fees deduction reduces your adjusted gross income. So there are different planningissues here.

In many instances you'll be better off just taking a credit, if you qualify, and reducing yourtotal tax bill.

But run the numbers. You could get more benefit by taking the tuition and fees deduction andreducing your AGI. Here's why.

Let's say your AGI is $112,000. Well, at $110,000 your child tax credit starts to diminish. Ifyou can lower your AGI with the tuition and fees deduction, you'll then qualify for the full childtax credit and still get to deduct up to $4,000 of tuition expenses, notes Burlison.

It's really important to try different scenarios, especially if there are multiple students inthe house. H&R Block's Web site has an

Education Tax Benefits Estimator that can help you decide whether the creditsor the deductions will work best.

Here are a few more things to consider:

If you or your spouse is taking a class to improve your current job skills, any expensesother than those you use with the Lifetime Learning credit or the tuition and fees deduction can bededucted as miscellaneous itemized deductions on Schedule A -- Itemized Deductions, notesBurlison. So that includes the remaining costs of your tuition in addition to books and otherfees.

Married people who are filing separately are not eligible for the Hope Credit, Lifetime LearningCredit, or the tuition and fees deduction.

If your child is working and you do not claim him or her as a dependent, it might be better for the child to take one ofthese credits because the AGI will be lower than yours.

So be sure to crunch some numbers. You want to make sure that while little Johnny is havingthe most expensive time of his life, you're keeping some money in your pocket.

Tracy Byrnes is an award-winning writer specializing in tax and accounting issues. As a freelancer, she has written columns for wsj.com and the New York Post and her work has appeared in SmartMoney and on CBS MarketWatch. Prior to freelancing, she spent four years as a senior writer for TheStreet.com. Before that, she was an accountant with Ernst & Young. She has a B.A. in English and economics from Lehigh University and an M.B.A. in accounting from Rutgers University.

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