Education and Taxes

What’s the first word that comes to mind when you think about education…taxes, right? Well, even if it’s not the first thing that you think about, the expenses of higher education for a taxpayer or dependent can save money on taxes, via a deduction or a credit. A deduction will save you taxes based on your top marginal tax rate, so for example, if you’re in the 25% tax bracket, a dollar spent on qualifying education costs will save you twenty five cents in tax. A credit is much more powerful, since it directly reduces your tax, so if you have a tax credit of a dollar, it will save you a dollar in tax. This discussion will tell you about a few ways that Uncle Sam can help you pay for higher education costs.

American Opportunity Credit-this credit can be claimed for four years of post-secondary education per student, with a maximum annual credit of $2,500 per student. The full credit is available to single taxpayers with modified adjusted gross income (MAGI) of $80,000 or less, and married couples filing jointly, with MAGI of $160,000 or less. The credit phases out for MAGIs above those thresholds.

Lifetime Learning Credit-this credit can be claimed for all students enrolled in eligible educational institutions, and is up to $2,000, period, regardless of how many students are claimed on a tax return. Unlike the American Opportunity Credit, there’s no limit on the number of years a student may claim this credit, though only one credit or the other may be claimed in one year, not both. This credit is handy for graduate students (who have already received the maximum of four years of American Opportunity Credit), students who are taking only one course, or people who aren’t pursuing a degree.

Tuition and Fees Deduction-as I mentioned above, credits are more valuable than deductions, but if taking this deduction nets more tax savings than, say, the Lifetime Learning Credit, then you claim the one that saves the most. Similar to the Lifetime Learning Credit, the maximum deduction is $4,000, regardless of how many students are claimed. This deduction phases out with the same thresholds as the American Opportunity Credit.

Student Loan Interest-generally, personal interest paid (other than home mortgage interest) is not deductible. If MAGI is under $75,000 single/$150,000 married filing jointly, interest on student loans to pay for higher education is deductible, up to $2,500 per year.

There are other ways that education expenses can save you tax dollars, and, as with anything having to do with IRS and tax laws, there are numerous requirements, thresholds, and fine print, so make sure you speak to your favorite CPA (hint hint) if you have any questions. Have you saved taxes with higher education expenses? Please leave a comment about how you did it. As always, forward this article to somebody you know who could benefit from it, and let me know other topics you’d like to see me write about.

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Inflation and Taxes

Can you believe that inflation could produce tax savings? Believe it or not, it’s possible. Starting in 2012, various deductions, exemptions and exclusions will be adjusted (i.e. increased) for inflation, which could produce increased tax savings from 2011 amounts.

Retirement Plans-for 2012, the maximum 401(K) contribution increases from $16,500 to $17,000. For individuals who participate in employer sponsored retirement plans, and also make traditional IRA contributions, the income phase out range will increase from $56,000 through $66,000 for a single taxpayer in 2011, to $58,000 through $68,000 in 2012. For married taxpayers, the phase out increases from $90,000 through $110,000 in 2011, to $92,000 through $112,000 in 2012. What this means in plain English is that it’ll take more income in 2012 to phase out the deductible IRA contribution than it does for 2011.

Income Tax Brackets-though it’s anybody’s guess when (or if) tax rates will change from the current 10, 15, 25, 28, 33, and 35 percent amounts, inflation will have an effect of lowering tax bills, based on having more income fall into lower brackets in 2012 than they do for 2011.

Standard Deduction-for taxpayers who don’t itemize deductions, the standard deduction for single taxpayers will increase from $5,700 in 2011 to $5,950 in 2012. For married taxpayers, the increase will be from $11,400 to $11,900.

Personal Exemptions-these will increase from $3,700 in 2011 to $3,800 in 2012.

Estate Tax Exclusion-the current $5,000,000 exclusion will increase to $5,120,000 in 2012.

Gift Tax Exclusion-sorry, gotcha on this one! The annual gift tax exclusion will remain at $13,000 ($26,000 for married taxpayers who elect gift-splitting).

While none of these represent any giant tax windfalls to taxpayers, any opportunity to save a few bucks in taxes is a good thing, right?

How are you going to save more in taxes in 2012? Let me know, or else feel free to leave other tax related comments. As always, feel free to suggest a topic for a future article.

Tax Simplification? I Think Not!

I participated in a tax update webinar the other day, and I wanted to pass along a couple of changes that probably affect most taxpayers in this country. The common thread between the two changes is that they point out how tax preparation is becoming more complicated (and not to be attempted by amateurs), and just how much ‘big brother’ is watching.

Credit Card Sales By Businesses-Beginning with tax year 2011, credit card companies will be sending Form 1099-K to all credit card accepting merchants/businesses. Form 1099-K is titled “Merchant Card and Third Party Network Payments”. Guess what…every penny that customers charge to pay for a business’s goods and services is going to be reported to IRS, and wait, it gets better. The form breaks down the annual total by month, which will make it easier for IRS to trade information with all of the states, who, in turn, will match the information up with sales tax returns being filed every month (or quarter). Additionally, on business returns, line 1 reporting has gotten more complicated. Starting with 2011 tax returns for businesses (Forms 1065, 1120, 1120S, even Schedule C for sole proprietors), line 1 gross receipts reporting will now be split out to one line for credit card income and one line for all other income. If a business accepts credit cards but doesn’t report that income on the credit card line (i.e. includes it with all the other income), I’m almost willing to bet that they’ll receive an inquiry from IRS. If the gross sales on sales tax returns doesn’t amount to at least the amounts reported on the 1099-K, I’d bet an inquiry from the state will be coming, too. This is all pretty scary stuff!

Securities Sales Reporting, and Reporting of Basis-If you have any type of securities account (through a broker or through a mutual fund, etc), you may have already received a piece of mail talking about how the broker/fund is going to be required to report to IRS the basis of securities sold. The letter also describes what method the broker/fund will use to compute the basis (such as ‘first-in first-out’, average cost, etc). There’s a possibility that you ignored this letter, and may have even thrown it out. I recommend that you read this letter, and understand it, as the ‘default’ the broker/fund will use may not be the best for you tax-wise. In addition to this change in reporting by the brokers/funds, the way you report securities sales on your tax return is going to get WAY more complicated. Describing all the changes can be an article in itself, but let me say that you’re not only going to have to file Schedule D (as in the past), but Form 8949 will also need to be completed…as many as six times! In short, separate Forms 8949 need to be filed for short and long-term gains or losses, as well as for gains or losses where the broker reported the basis, gains or losses where the broker didn’t report the basis, and gains or losses where a Form 1099-B wasn’t received from the broker.

As with air travel these days, when this tax season rolls around, you’re going to have to pack a little patience, and be prepared for more questions from your tax professional, as we’re going to have a lot more work to do for preparing business and personal returns on behalf of our clients.

Please pass this article along to anybody who may benefit from the information. As I said at the outset, these two changes alone will affect a large percentage of business and personal taxpayers, so chances are you personally know more than a couple of people who will be affected. Please leave a comment about your thoughts on these two new tax developments.