Free College Money Part 2: Tax Programs

February 6, 2008 By Erica Barton

This article is the second in a five-part series on how to find free college money. Below, there are eight great ways to get free tax money for any student’s college education and include an explanation of each.

TAX-FREE MONEY: There are several tax-free programs that can be used to help any student get a college degree. Here are three that can help increase your student college fund, or save you thousands of dollars in college costs.

1. Qualified Tuition Program (a.k.a. 529 Plans or QTP): The biggest benefits to investing in a QTP is that qualified education distributions are exempt from federal income tax, there are no limitations on income or age, and generally there are no restrictions on annual contributions. Although your contributions are not tax-deductible when you make them, anyone can take advantage of a 529 plan and remain in control of that plan. As long as the plan remains in someone else’s name, it is not considered the student’s money when they apply for financial aid (thus qualifying them for more aid). Plus, if you invest in one of the 529 Plans within your state of residence, you can receive other benefits (such as corresponding grants and scholarships, and protection from creditors). In addition, your state may also offer some tax breaks like an upfront deduction for your contributions or state income exemption on withdrawals. Although the 529 plans’ provisions were originally set to expire in 2010, the Pension Protection Act of 2006 made the provisions permanent.

The two types of 529 Plans are:

· 529 Prepaid Plans: Prepaid plans allow contributors to purchase tuition credits at today’s rates and the advantages are based on tuition inflation. Both states and higher education institutions may administer the prepaid plans.

· 529 Savings Plans: Savings plans growth is based on investment performance and may only be administered by states.

2. Coverdell Education Savings Account (ESA): Each year, anyone can deposit up to $2,000 per student into an ESA and allow the money to grow tax-deferred with distributions being tax-free for qualified education expenses at qualified educational institutions. Qualified educational institutions include grades K-12 at qualifying schools as well as colleges and universities. ESA contributions can be placed into almost any type of investment including stocks, bonds, and mutual funds, and unlike a 529, ESAs can only be contributed into a student’s account as long as the student is less than 18 years of age. Furthermore, excess balances not going toward qualified education expenses must be distributed or transferred to a new qualifying student by the time the original student is 30 years old in order to avoid taxes and penalties (unless the student is a special needs student).

3. COLLEGE CREDIT THROUGH HIGH SCHOOLS: Every high school receives a pre-determined amount of money for each attending student. However, not necessarily every dollar they receive has to be spent at their school. Many high schools are colluding with local community colleges to offer college credits to students willing to attend college night classes…and the high school pays for it. There are even programs where your child can attend college classes instead of high school classes when they are as young as 14 years old. By the time your child graduates high school, they could have an Associate’s Degree as well as a high school diploma…and all on your high school’s dime. Check with your local community college and at your local high schools to see what kind of programs they offer.

Tax Credits: Unlike a tax deduction (which reduces the amount of income subject to tax), a tax credit directly reduces the amount of income tax you might have to pay. For each student’s qualified education expenses, you can take advantage of one credit per year to pay less tax and keep more of your own money, but you cannot use both credits simultaneously. (Click here to see all of the IRS’s qualifications and restrictions.)

4. Hope Credit: If your student is in the first two years of college, you may be able to claim the Hope Credit of up to $1,650 for qualified education expenses paid for EACH eligible student. The Hope Credit is a nonrefundable tax credit that can reduce your tax to zero, but any excess credit will not be refunded to you. A qualifying student must be enrolled at least half time in at least one academic period, and they must be pursuing an undergraduate degree or other recognized education credential. (The Hope Credit may be limited by your income and tax and can only be claimed for a maximum of two years per student.)

5. Lifetime Learning Credit: For any year where you pay for a student’s qualified education expenses, you can receive a $2,000 nonrefundable tax credit PER RETURN. This credit is available for all years of postsecondary education. The student does not need to pursue a degree or other recognized education credential and it is available for any number of courses. It can also be claimed an unlimited number of years.

TAX DEDUCTIONS: Tax deductions lower your taxable income saving you money, lowering the amount of taxes you need to pay, and possibly qualifying you for a tax refund. If you claim enough tax deductions, you could very easily walk away with a nice refund to reimburse your college expenses. Below are three of the most common.

6. Tuition and Fees Deduction: Depending on your income, you can deduct up to $4,000 of qualified education expenses per year from your taxable income if you have a qualifying student. (Qualified education expenses include tuition and fees required for enrollment or attendance at an eligible postsecondary educational institution, but not personal, living, or family expenses, such as room and board.)

7. Student Loan Interest Deduction: Depending on your income, you can deduct up to $2,500 of student loan interest from your taxable income if you have a qualifying student and student loan. To qualify, the loan cannot be from a relation or a qualified employer plan and the student must be enrolled at least half time in a degree program. Even better, depending on your income level, you can take this deduction every year of the student loan’s remaining life.

8. Employer-provided educational assistance: If you receive educational assistance benefits from your employer, you can exclude up to $5,250 of those benefits from your taxable income annually. The payments may be for either undergraduate or graduate-level courses and they do not have to be work-related. (Tax-free educational assistance benefits include tuition, fees, books, supplies, and equipment.)

Check out the third article in this five-part series “Free College Money Part 3:  Hundreds of Grants.”  It lists common college grants anyone can qualify for, where to find them, and how to qualify for them.  Also, if you have not read the first article showing you how to turn pennies into thousands (“Free College Money Part 1: Starting with Pennies”), click here to be taken directly to it.

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