Q: "I have an older sister who wants to help me pay for college since our parents aren't financially stable right now. What's the best way for her to help me without putting herself into a bad tax situation?" - Max, San Diego
A: First off, you should know that if your sister gives you or your parents more than $13,000 a year, she will have to file a gift tax return and start using up her lifetime gift tax exclusion.
The Hope Scholarship tax credit is another option, but to claim it the taxpayer (your sister) must be able to claim the student (you) as an exemption on her federal income tax return. The Hope tax credit allows up to $2,500 to be deducted based on the first $4,000 in college costs paid by the taxpayer. Since there is little likelihood of you being considered a dependent on your sister's return, she should just give the money as a gift to you and your parents.
If your parents claim you as an exemption, they get to claim the tax credit, but if they allow you to claim yourself as an exemption, you can obtain the tax credit yourself. But you will not be eligible for the partial refundability. So your sister will need to examine the tradeoffs of giving the money to you or to your parents to determine which option yields the greatest tax benefit.
Your sister is not eligible to borrow from federal education loan programs, since only students and parents are, but she can help you and your parents with the loan payments after you graduate.
You, the student, can borrow from the federal Stafford loan program regardless of your credit or your parents' credit. Your parents can borrow from the federal Parent PLUS loan program if they do not have an adverse credit history. An adverse credit history is defined as a five-year look-back for certain derogatory elements in a person's credit history, like a bankruptcy discharge, repossession, foreclosure, tax lien or wage garnishment or a current delinquency on any debt of 90 days or more.
If your parents are denied a Parent PLUS loan because of an adverse credit history, you will be eligible for the higher unsubsidized Stafford loan limits available to independent students. These loan limits are $4,000 a year higher during the freshman and sophomore years and $5,000 a year higher during the junior and senior years in college.
However, even if your sister is making loan payments for you, she will not qualify for the student loan interest deduction. That deduction allows only the borrower to deduct up to $2,500 a year in student loan interest as an above-the-line exclusion from income on the federal income tax return. This means you can take the deduction even if you don’t itemize. But only the taxpayer who is legally obligated to make the loan payments can take the deduction.
However, you can take the deduction based on the payments she makes on your loans.
She could also help you qualify for a private student loan by co-signing for you. Private student loans are much more expensive (in terms of interest) than federal student loans though, so it is best to borrow at the federal level first. Also, a co-signer is a co-borrower, equally obligated to repay the debt. If you make the payments late, the delinquency will ruin both of your credit histories.
—Mark Kantrowitz is president of MK Consulting Inc. and publisher of theFinAid.org and FastWeb.com. He has testified before Congress about student aid on several occasions and is on the editorial board of the Council on Law in Higher Education.
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