Monthly Archives: February 2015

College Tax Credits and Divorce

Divorced parents are probably already well aware that the financial piece of planning for college is mystifying at best. With tax season upon us, divorced parents planning to claim one of the available college tax credits– American Opportunity Tax Credit or Lifetime Learning Credit– need to know that the credit is only available to the parent who claims the student as a dependent on their tax return. This is different from the FAFSA, which is completed by the custodial parent.

Keep in mind that both tax credits have income caps: the AOTC (a credit of up to $2,500 per year per student for four years) phases out between $80,000-$90,000 for single filers; the LLC (a credit up to $2,000) phases out between $52,000-$62,000 for single filers. In many cases, only the lower-earning ex-spouse is eligible for one of the credits whereas the higher-earning ex may be taking the dependent deduction, so it may take some calculation to determine the net benefit of shifting the dependent in order to get the tax credit.

529 Plans and AMT

Many two-income Oregon families end up owing AMT due to our two-legged tax “stool.” That’s because, absent sales tax, we pay higher income and property taxes. For most non-1%-ers who end up owing AMT, state taxes are the biggest add-back item in the AMT calculation.* That means that if you’re paying AMT, a 529 plan contribution can be doubly beneficial.

Without AMT, your state taxes are deductible against your federal income. So when you reduce your state income taxes, you also increase your federal income taxes. Let’s say you’re in the 25% federal tax bracket and you made the full deductible (Oregon) 529 contribution in 2014, $4530 (married filing joint). Your state taxes would decrease by $407.70 (9% of $407.70.) That, in turn, reduces your federal deductions by $407.70, meaning you’d pay an extra $101.93 in federal income taxes for a net tax benefit of $305.77.

With AMT, your state taxes are one of several items added back to your calculated taxable income. Then that figure, net of your Exemption Amount, is taxed at 26% or 28%. So decreasing your state income taxes decreases your AMT add-back items which decreases your federal AMT tax.

Note that AMT, like all federal tax calculations, calculates based on the amount of state tax paid during the year, not tax due. To maximize the tax benefit of a 529 plan contribution, you’ll want to adjust your withholding to account for the tax deduction.

*Refresher course: The AMT, or alternative minimum tax, computes some tax items differently and taxes at a flat rate, rather than the progressive rate of regular tax tables. Some tax deductions that are allowed in the normal tax calculation, including state taxes, are added back in the AMT calculation and therefore are not deductible against federal income.

Trends in College Pricing

The College Board’s 2014 Trends in College Pricing report highlights some interesting points about the cost of attending college.

One item stood out in particular to me: While average published prices increased from the 2013-2014 to 2014-2015 school year in all higher ed sectors (by 2.9% for four-year public in-state, 3.3% for four-year public out-of-state, and 3.7% at four-year private non-profits), average net prices– the price students actually pay– is on a slight downward trajectory. (Unfortunately, the data for this is slightly less current because accounting for scholarships and tax credits takes more time than does surveying published prices.)

While that’s good news, it’s important to look at college pricing not just in terms of its own inflation, or CPI inflation, but in terms of household income. It may be good news to say that public in-state tuition rose by less than 1% more than the CPI from 2013-2014; however, the long-term trend of income gains versus tuition increases shows a disturbing trend: for all but the top 20% of families, average income was lower in inflation-adjusted dollars in 2013 than it was in 2003. As the College Board says, “Average published tuition and fees for in-state students attending public four-year colleges rose by $6,324 (in 2014 dollars) between 1983 and 2013– 71% of the increase in income ($8,936) of the middle 20% of families” and far more than the $578 increase for the lowest quintile. Similarly, the average net price paid by in-state students at public four-year colleges increased by about $1,000 in just the last five years. This is the actual amounts paid, net of aid, not just the published prices.

Obviously, we have a long ways to go to make college accessible to qualified students.

The entire report is available here.

Pell Grants for 2015-2016

One of the great things about filling out the FAFSA is, you become eligible for all the federal aid that’s out there. Pell Grants are one form of aid that many people are surprised to find they’re eligible for. Pell Grants are awarded on a strict need basis. However, because of the way the aid formulas work, a middle-class family with several students in college at the same time may find themselves qualifying for Pell Grants. Grants are the best form of financial aid because they do not have to be repaid, so you absolutely want to be sure to make yourself eligible for any that are out there. For the 2015-2016 school year, the Pell Grant EFC cutoff for full-time students is $5,198. Remember that although EFC is calculated per family, need is calculated per student. So in a family with multiple students in college at the same time, the calculated EFC may be divided by a factor comparable to the number of students the family has to determine Pell Grant eligibility.