Are Education Expenses Deductible?

Also, recovering foreign taxes withheld and explaining capital-gains rates.
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No Hope for Education Credits

My wife is currently enrolled as a full-time graduate student. We both also worked full-time last year. We file our tax return jointly, and I believe we make much too much to qualify for either the Hope or Lifetime Learning credit. Can we deduct her tuition, fees and travel expenses on Schedule A under miscellaneous deductions? -- Matthew Soucek

Matthew,

The Hope Scholarship and the Lifetime Learning

credits are new for 1998. Both credits phase out when adjusted gross income is between $80,000 and $100,000 for married people filing jointly or $40,000 and $50,000 for single taxpayers.

If your income is too high for these credits, you have another option. If your wife was working full time while going to school, her education expenses can qualify for a miscellaneous deduction if those deductions on

Schedule A --

Itemized Deductions

exceed 2% of your adjusted gross income.

The purpose of her coursework must have been to improve her current trade or business. Taking courses to prepare for a career change doesn't count.

Assuming your wife's studies meet these tests, the expenses would be deductible as business expenses, which are subject to the 2% limitation mentioned above, says Bill Fleming, director of personal financial services for

PricewaterhouseCoopers

.

What expenses qualify? Money spent for tuition, books, supplies, laboratory fees, academic or vocational courses, refresher courses or courses dealing with current developments, according to the

Research Institute of America

.

But if your wife was a full-time student last year and did

not

work full time, she cannot take a deduction for any of these expenses.

Check out

Publications 508 and 970 for more on education expenses and the new higher education credits.

Israelis Withheld My Income

I have an IRA account with a broker. I received a dividend in December from Matav Cable Systems Media (an Israeli company). My statement showed a deducted amount as "foreign tax withheld at source." How do I handle this on my federal income tax return? -- Maurice P. Redsinski

Maurice,

Because the foreign security is in your tax-deferred account, you do not pay tax on any of the income the account generates. As a result, you cannot get a credit for any taxes withheld on that money. So essentially, you lose it.

Things are very different in a taxable account, though. In this case, you would have the opportunity to reclaim some of taxes the foreign country withheld. The reason foreign countries withhold tax "at the source" is to collect their money immediately. Otherwise you might never file an Israeli tax return for the income you received from the country.

But you should get a credit back from the U.S. for the money you paid to Israel. Essentially, you shouldn't have to pay tax twice on that money.

In previous years, when you had foreign taxes withheld, you were required to file

Form 1116 --

Foreign Tax Credit

to get that money back when you filed your

Form 1040 --

U.S. Individual Income Tax Return

. But Form 1116 is cumbersome and confusing.

Thanks to new 1998 rules, you might not have to file Form 1116 at all, says Nick Morrow, foreign tax specialist at

Martin Geller

, a New York accounting firm.

Here's how you can skip the form. First, the foreign income you received must be from interest and dividends only. If your total foreign taxes don't exceed $600 for married couples filing jointly or $300 for single filers, you can just plop your total foreign tax amount, a.k.a. the amount withheld, on line 46 of your Form 1040. You would not have to deal with the nuisances of Form 1116.

But if you do not meet the requirements above, then you must walk through Form 1116 to be able to take the foreign taxes withheld as a credit on your tax return. Check a previous

story for more on Form 1116 and the foreign tax credit.

What Are the Capital-Gains Rates?

If you are a trader, are you taxed at the 38% capital-gains rate for short-term holdings? Is that a flat rate for everyone or can you be charged a higher rate if your personal tax rate is higher? What is the tax rate for investments? What is the minimum holding time for a stock to qualify as that type of investment? -- Autumn Henry

Autumn,

Here's a basic rundown that applies to everyone, trader and investor alike. For stocks held at least 12 months and a day, any gains at the time of sale will be taxed at the long-term preferential rate of 20% (or 10% if you are in the 15% ordinary income tax bracket).

Any gains generated from sales of securities held less than a year will be taxed at your ordinary income tax rate. That could be 15%, 28%, 31%, 36% or 39.6%, depending on your income. To find which tax bracket your income falls into, check out these

tax tables.

OK, so that's pretty straightforward. The confusion sets in when you elect special trader status. See our

Taxes for Traders series for all the details.

But thanks to the Taxpayers' Relief Act of 1997, a trader can choose to report capital gains or losses in one of two ways:

On

Schedule D --

Capital Gains and Losses

, like everyone else. Then any long-term gains will qualify for 20% preferential treatment, just like everyone else's gains. And short-term gains would be taxed at the ordinary rate.

Or on

Schedule C --

Profit or Loss From Business

. To do this, a trader must

elect to mark to market all his or her trades at year-end, which means treating them as if they were sold at the market rate on the last day of the year. Then all gains and losses will be treated like business receipts and will be taxed at the ordinary tax rate, regardless of the time held.

TSC Tax Forum aims to provide general tax information. It cannot and does not attempt to provide individual tax advice. All readers are urged to consult with an accountant as needed about their individual circumstances.

As originally published, this story contained an error. Please see

Corrections and Clarifications.