Category Archives: Tax Credits and Deductions

AOTC vs EFC

It’s not unusual for different strategies to be more helpful at different points in the college savings/funding process. Retirement contributions are a perfect example.

For many families, it’s beneficial to use Roth contributions in FAFSA years because the additional taxes paid reduce EFC. Taxes paid are subtracted from available income, so a family in the 22% tax bracket who maxes out Roth IRAs instead of traditional IRAs for both spouses would see their EFC reduced by $1,240. ($12,000 x 22% marginal tax rate x 47% marginal EFC income assessment rate = $1,240.)

However, if that family is approaching the income limit for the American Opportunity Tax Credit (MAGI of $160,000 for married filing joint in 2019), then contributing to Roth IRAs in a year in which their student is in college might leave them unable to claim the AOTC. The AOTC is worth up to $2,500 per year, per student, so it’s often worth more than the EFC savings. But there may be circumstances where parents want to do additional analysis, such as if the student is at a financial aid “threshold” amount where adding $1,200 to their EFC would result in a larger loss of aid. This might be the case for a student receiving a subsidized loan, for example.

For families looking at this situation, the key piece is whether they’re receiving need-based aid or on a need-based aid path for subsequent students. If the student is receiving need-based aid, it’s worth a conversation with the school’s financial aid office to confirm that you are not shooting yourself in the foot if you change your retirement savings contributions to maximize AOTC eligibility. And for those with additional children approaching college age, it’s a good practice to try out some net price calculators at schools of interest to determine the impact.

Worth noting: Although a student attending college for four years will have college expenses in five tax years, the AOTC can only be claimed for four years. Given the FAFSA and Profile using prior-prior year incomes (i.e., the FAFSA families complete for the 2020-2021 school year will use 2018’s income), there are a maximum of two potential years of overlap per child between AOTC and EFC. Families with multiple students will have more such years.

Scholarships and Taxes

Do you have to pay taxes on a scholarship? It depends what the scholarship is for. To understand taxes on scholarships, it’s worth remembering that the IRS defines qualified expenses differently for different purposes. Expenses get more or less the same treatment for taxability of scholarships as they do for education tax credits, so let’s review those. Continue reading Scholarships and Taxes

529 Withdrawals

529 withdrawals are always pro-rata contributions and earnings. That means that if you contributed $30,000 to your account over the years and it’s now worth $40,000, then your withdrawal will be 75% contributions and 25% earnings. That’s moot in the case of a qualified withdrawal, but it matters for a non-qualified one: tax and penalties will apply to the earnings portion. On the federal side, it’s taxed at the marginal rate of the person Continue reading 529 Withdrawals

Why 529s Always Make Sense

It’s easy to explain to parents of younger children why 529s make sense: Contribute now and your account grows tax-free for 18 years until college. If you live in one of the more than 30 states that offers a tax deduction, that’s an even bigger incentive. Here in Oregon, for example, we get a tax deduction for the first $4,865 in contributions to the Oregon College Savings Plan. If I contributed that much for my newborn (well, they act like newborns sometimes) I’d get an immediate return of 9% (state tax rate) or $437.85. Suppose that my account then grows for 18 years at 5% (I’m drastically simplifying the math here), I’d have almost $12,000 when my child was ready to start college, and no tax bill to access it. Added bonus: the FAFSA and Profile don’t count that gain as income in their formulas, unlike how it would be treated if it were in a taxable account. Continue reading Why 529s Always Make Sense

What’s in a 1098-t

(and what isn’t)

A 1098-t is a tax form that serves several purposes. It reports qualified tuition and fee payments made to your college, as well as scholarships received to offset those costs. But qualified expenses is a big tent-type of phrase that means different things in different situations. All by way of saying, your 1098-t is not an exhaustive list of qualified expenses. Continue reading What’s in a 1098-t

To Borrow or Not to Borrow

Planning for college cash flow can be tricky. It’s not just that the average public university costs over $25,000 per year whereas the average family has saved just over $18,000 total. There’s also the combination of tax credits and their attendant rules, a confusing menu of borrowing options, and misunderstandings about how aid formulas treat savings. Add multiple children with overlapping college years and it’s no wonder many parents throw up their hands in despair. One common theme I hear from parents is a version of, “We’ll just spend our savings until it’s gone and then borrow what we need.” This may or may not be the right answer. Continue reading To Borrow or Not to Borrow

AOTC And New Tax Law

One of the big changes to the tax bill was making our young adult children less valuable to their parents from a tax perspective. The dependent exemption is gone and the child tax credit for 18- to 23-year-old dependents is only $500. The change does open a door to higher-income families for the American Opportunity Tax Credit, though.  The AOTC phases out at MAGI of $160,000, so it’s not unusual for families to be ineligible but to still find college unaffordable.

Here’s how the AOTC works, from irs.gov: Continue reading AOTC And New Tax Law

What’s a Qualified Expense?

Qualified expenses (QHEE’s) are expenses that are eligible for some form of tax benefit such as the AOTC or a tax- and penalty-free distribution from a 529 account. Sounds simple, right? Let the fine print begin! Not all “qualified expenses” qualify for all purposes. And of course the most important rule of claiming education tax benefits: You can’t double-dip. That means that if you use 529 plan funds to pay an expense, you cannot also claim a tax credit for that expense. Continue reading What’s a Qualified Expense?

What Year?

With the change to prior-prior tax year reporting on the FAFSA and CSS PROFILE, it seems that keeping track of what data dates pertain to what is becoming increasingly complicated. This table summarizes the relevant years or dates for each school year.

School Year 2018-2019 2019-2020 2020-2021 2021-2022 2022-2023 2023-2024 2024-2025
FAFSA/ PROFILE Income Year 2016 2017 2018 2019 2020 2021 2022
Assets As Of October* 2017 2018 2019 2020 2021 2022 2023
AOTC Tax Year** 2018, 2019 2019, 2020 2020, 2021 2021, 2022 2022, 2023 2023, 2024 2024, 2025

* Assets are as of the filing date, which may be as early as October or into the following year depending on the school’s filing date.

** Remember that the AOTC can only be claimed for four tax years, so families should decide whether the fall of freshman year is better than spring of senior year for claiming. With the income limit of $160,000 (married filing joint) or $80,000 (single), some families might not be eligible every year.

Parents may find that different strategies are needed during different years. For example, a family with a student beginning college in fall of 2020 might reduce pre-tax retirement contributions this year (to increase taxes, which are deducted from income on the FAFSA and therefore reduce EFC) and then maximize contributions beginning in 2021 to reduce AGI for AOTC claiming purposes.