Coverdell Education Savings Account Irs

Tax planning for parents of college students: help clients form a strategy from the Code’s array of options.

As parents plan for their children’s higher education, they
may choose from an array of tax-favored savings vehicles and deductions
and credits. Options include education savings plans, education credits,

 in logic, form of inference such that the conclusion must be true if the premises are true. For example, if we know that all men have two legs and that John is a man, it is then logical to deduce that John has two legs.
 of educational expenses, education savings bonds, education
loans and other alternatives. No single option works best for everyone,
but by reviewing the pros and cons of each alternative, families can
choose a strategy that best meets their needs. Since planning for
college education should start when children are young,

practitioners should offer these services to new parents as well as
those with children currently in college. Yearly tax organizers should
include questions about tax planning for college. When conducting
yearend tax planning for parents of college students, CPAs should
discuss related issues, including the dependency exemption on
parents’ returns during their children’s college years.

As the need for a college degree has increased, the cost of going
to college has also increased.
According to

1. As stated or indicated by; on the authority of:

2. In keeping with:

 The College Board, for the
2011-2012 academic year, the average annual m-state

 and fees at
a public four-year college are $8,244, and the average total
out-of-state tuition and fees are $20,770. The average annual tuition
and fees at private

 colleges are $28,500 (
These costs do not include room and board, books or supplies. According
to The Project on Student Debt, the average college senior graduating in
2010 owed $25,250 in student loans ( Families
therefore have good reason to start saving toward these costs while
their children are young. Savings vehicles include Sec. 529 plans,
education savings bonds and Coverdell education savings accounts
(Coverdell ESAs). All of these plans have their merits. (See the
SEC’s overview of Sec. 529 plans at Families
without savings can still take advantage of the following tax incentives
once their children are in college.


Most students have little or no tax liability while in school;
therefore, it is usually beneficial for their parents or guardians to
claim them as dependents. CPAs might start by reviewing with clients the
tests that must be met for a qualifying child (Sec. 152). They are:

Relationship. Naturally, a taxpayer’s own children meet this
test, but a child’s descendant or a brother or sister or descendant
of a brother or sister can also meet the definition of a qualifying
child for the purpose of claiming a dependency exemption (Sec.

Residence. A qualifying child must have the same residence as the
taxpayer for more than half of the year; however, a student living away
from home while in college is considered to be living in the same
residence as the parents (Regs. Sec. 1.152-1).

Age. A qualifying child must be under age 19 or be a full-time
student under age 24. For purposes of this test, a student must be
enrolled in an educational organization, in what the college or
university considers full-time attendance, during part or all of each of
any five months in a calendar year (Sec. 152(f)(2)). Meeting this
requirement can be difficult if the student does not sign up for a full
load of classes or withdraws from some classes. Full-time attendance is
defined by most universities as at least 12
One of two divisions of 15 to 18 weeks each of an academic year.

[German, from Latin (cursus) s
 hours. Both fall
and spring semesters usually include at least parts of five months.

Support. The student must not provide over half of his or her own
support (Sec. 152(c)(1)(D)). The parents do not necessarily have to
provide over half the support.
College tuition

 and fees are included in
the cost of support. If the parents pay these costs, the child may meet
the support test even if the child pays most of his or her own living
expenses. However, if a student pays the cost of tuition and fees or
receives a student loan to pay them, that amount is counted as support
provided by the student and can cause the child to fail the support test
and thereby not qualify as a dependent. If a parent takes out a loan for
the student, however, amounts paid for support from the borrowed funds
count as support provided by the parent.


Income from scholarships is not included in the calculation of
support of a taxpayer’s child (Sec. 152(f)(5)) (see
“Scholarships and Support,” JofA, May 2011, page 56). The

 has not given guidance on how distributions from Sec. 529 plans affect
the support tests. These distributions can be substantial. If the
distribution is counted as support provided by the

it could prevent the child from qualifying as a dependent. Sec. 529
plans allow the owner (usually a parent or grandparent) to change the
beneficiary. This provides some support for the argument that Sec. 529
plan distributions should count as support from the account owner and
not count as support provided by the child, but tax practitioners are
still waiting for a definitive answer from the IRS.

Joint return. Yet another dependency test requires that the student
not be married filing a joint return with his or her
  A legal marriage partner as defined by state law
solely to claim a

 (Sec. 152(c)(1)(E)).

A college student may alternately be the taxpayer’s dependent
as a qualifying relative, with tests at Sec. 152(d). For a detailed
discussion of the dependency rules, see “Dependency Exemption
Issues for College Students,” The Tax Adviser, Aug. 2010, page 546.


Deduction of student loan interest. The interest expense on
qualified education loans is

 if the taxpayer meets the income
limitations. The loans must be used to pay educational expenses for the
taxpayer, spouse or dependents. The loans can be used for tuition, fees
and supplies, as well as room and board and other necessary expenses
(Sec. 221). Up to $2,500 per year of interest paid on education loans is
deductible. This is an above-the-line deduction, so the taxpayer does
not have to

 to take advantage of it. However, the deduction
phases out when modified adjusted gross income (MAGI) is between
inflation-adjusted limits: $60,000 to $75,000 for single and
head-of-household fliers (for 2011 and 2012) and between $120,000 and
$150,000 for married fliers for 2011 (between $125,000 and $155,000 for

Married taxpayers filing separately cannot take the deduction. If
the student can be claimed as a dependent on another taxpayer’s
return, he or she cannot take a deduction for student loan interest
(Sec. 221 (c)). If the loan is in the student’s name, the parents
may not take the deduction even if they pay the interest. Parents can

v. de·duct·ed, de·duct·ing, de·ducts
1. To take away (a quantity) from another; subtract.

2. To derive by deduction; deduce.

 the interest only if the loan is in their name and they actually
pay the interest.

Deduction for tuition and fees. Taxpayers can claim a deduction
(also above the line) of up to $4,000 for qualified tuition and fees
they pay if they meet the income
guidelines a set of standards, criteria, or specifications to be used or followed in the performance of certain tasks.
 (Sec. 222). Qualified
expenses for this deduction include only tuition and fees. For 2011,
single taxpayers with MAGI less than $65,000 ($130,000 for
filing jointly

) can deduct up to $4,000 (Sec. 222(b)(2)(B)). For single
taxpayers with MAGI between $65,000 and $80,000, and married taxpayers
with MAGI between $130,000 and $160,000, the deduction is reduced to the
lesser of $2,000 or the amount paid. For single taxpayers with income
over $80,000 ($160,000 for married taxpayers), no deduction is allowed.
Married taxpayers filing separately are not eligible for the deduction.

Note that this provision expired at the end of 2011 and, unless

Influencing or applying to a period prior to enactment:

[French rétroactif, from Latin
 extended (as occurred in 2010 for that tax year through
2011), is not available for 2012 expenses.

For parents to claim this deduction, they must pay the tuition and
fees for their child, and they must claim the child as a dependent. The
deduction for tuition and fees cannot be taken for the same student in
the same year as the American opportunity tax credit or the lifetime
learning tax credit (Sec. 222(c)(2)). Additionally, the same expenses
cannot be used as qualified expenses for tax-free treatment of savings
plan distributions (such as Sec. 529 distributions) and the deduction
for tuition and fees or the education credits.


American opportunity tax credit. This credit is up to $2,500 per
student in a degree program for the first four years of college. The
first $2,000 is a dollar-for-dollar credit for qualified educational
expenses. The other $500 of the credit is 25% of the next $2,000 of
qualified expenses (Sec. 25A(i)). Eligible expenses for this credit are
tuition and fees and other required course expenses including books and
other course materials (Sec. 25A(i)(3)), but they do not include room
and board. The American opportunity tax credit phases out for single
taxpayers with MAGI between $80,000 and $90,000 and for married
taxpayers filing jointly between $160,000 and $180,000 (Sec. 25A(d)).

Forty percent of the American opportunity credit is

Children cannot claim the credit if they are a dependent on a
parent’s tax return; however, any
allowable expenses the dollar amounts allowable for each dental procedure covered by a dental insurance policy.
 paid by the
child can be treated as paid by the parents for purposes of calculating
the credit (Sec. 25A(g)(3)). The American opportunity credit is
currently authorized only through 2012, when, without congressional
action, the credit will

1. To return to a former condition, practice, subject, or belief.

2. To undergo genetic reversion.
 to the pre-2009
Hope scholarship credit

which was available only for the first two years of college attendance,
for a maximum annual

 credit (in 2008) of $1,800.

Lifetime learning credit

. The lifetime learning credit is 20% of
the first $10,000 of qualified educational expenses (Sec. 25A(c)), for a
maximum credit of $2,000 for any taxpayer; therefore, a taxpayer with
multiple qualifying children is still limited to $2,000. The credit is
allowed for qualified tuition and related expenses even if for only one
class that is not part of a degree program. As is the case for the
American opportunity credit, eligible expenses do not include room and
board, and, unlike with the American opportunity credit, they do not
include books and other course materials. The lifetime learning credit
is not limited to the first four years of college, so it is available
for graduate school. The lifetime learning credit phases out for single
taxpayers with MAGI between $52,000 and $62,000 for 2012 ($51,000 and
$61,000 for 2011) and for married taxpayers between $104,000 and
$124,000 ($102,000 and $122,000 for 2011).


A $2,500 credit from the American opportunity credit is more
beneficial than a $4,000 tuition and fee deduction at any current tax
rate. The income phaseouts are also higher for the American opportunity
credit. For the first four years a child attends a regular
degree-granting college or university, parents are better off claiming
the American opportunity credit if they qualify

Exhibit 1 shows a comparison for a family of four with two children
in college. The parents have a combined salary of $100,000 and pay
$4,000 of tuition and $1,000 for course-required books for each of their
children, who are 20 and 21 years old and can be claimed as dependents
on the parents’ joint tax return. The total qualified educational
expenses for the American opportunity credit are $5,000 for each child.
This results in a $2,500 credit for each child ($5,000 total credit).

For the lifetime learning credit, only expenses of $8,000 for both
children are qualified educational expenses, because the $1,000 per
child for books does not qualify. Therefore, if neither child qualifies
for the American opportunity credit, the lifetime learning credit is
$1,600 ($8,000 x 20%). A taxpayer may not claim two education credits
(American opportunity credit and lifetime learning credit) or one
education credit and the deduction for tuition and fees for the same
child in the same year. However, taxpayers are allowed to claim the
American opportunity credit for one child and the lifetime learning
credit for another child (or for the parents). Column 3 of Exhibit 1
assumes one child qualifies for the American opportunity credit but that
the other child qualifies only for the lifetime learning credit. In this
case, the $4,000 for tuition and fees and the $1,000 for books qualify
for a $2,500 American opportunity credit for one child, and the $4,000
for tuition for the other child qualifies for a lifetime learning credit
of $800 ($4,000 x 20%). The $1,000 for books for the child eligible for
the lifetime learning credit does not qualify for a credit.

Tuition and fees of $8,000 are qualified educational expenses for
the tuition and fees deduction; however, this deduction is limited to
$4,000 total. The $2,000 expense for books does not qualify for the
tuition and fees deduction.

Exhibit 2 shows that the credits and the tuition and fees deduction
do not apply to room and board. Most full-time universities have tuition
and fees of at least $4,000 per year, which will use all the available
American opportunity credit. Sec. 529 savings plans and Coverdell ESAs
apply to room and board for students attending at least half time, as
well as tuition and fees. Therefore, it is beneficial to take
tax-advantaged savings plan distributions to pay for room and board and
pay tuition and fees with current income or loan proceeds to qualify for
one of the credits or the tuition and fees deduction. By careful
planning, taxpayers can maximize each benefit.

Example. Sally has $18,000 in a Sec. 529 savings plan. Her total
annual educational expenses are $9,000:$4,000 per year for tuition and
fees, and $5,000 per year for room and board. Sally could take a $9,000
distribution from her Sec. 529 plan in each of the first two years to
pay all of her expenses. The distributions would not be taxable.
However, she

would not qualify for the education credits in those years. Instead,
Sally could take a distribution from her Sec. 529 plan each year to pay
only the $5,000 needed for room and board. By paying tuition and fees
from non-Sec. 529 funds, Sally (or her parents, if she is a dependent)
could claim the American opportunity credit and receive a credit of
$2,500 for each of the four years she is in college.

If a student uses loan proceeds to pay qualified educational
expenses, the student is eligible to claim an education credit or the
deduction for educational expenses based on the amount of loan money
used to pay these expenses. Paying these costs with loan proceeds is
considered paying them out of the taxpayer’s own funds.


Some education benefits are available at the state income tax
level. Since many states start the calculation of state taxable income
based on federal adjusted gross income (

), the deduction for tuition
and fees could reduce state taxable income and, therefore, state taxes,
unless the state requires the amount to be added back for state income
tax purposes.

Interest earned on U.S. government savings bonds used for higher
educational expenses is exempt from federal taxation. While the interest
rates on these investments are low, these bonds are also exempt from
state income taxes.

Most states offer a deduction in calculating state income taxes for
contributions to that state’s Sec. 529 plan. A few states offer a
credit instead of a deduction (see


* Tax benefits that help families bear the high and growing cost of
higher education include deductions and credits, as well as tax-favored
savings plans,

* It is usually beneficial for the tax liability of the family as a
whole for a child in college to be claimed by his or her parents as a
dependent, Families should review the tests for qualifying children who
are full-time college students.

* Payments of student loan interest of up to $2,500 per year are
deductible “above the line,” as are up to $4,000 in qualified
tuition and fees. Both deductions are subject to modified adjusted gross
income phaseouts.

* In most cases, however, the American opportunity tax credit
and/or the lifetime learning credit will yield a higher tax benefit for
qualified educational expenses. Notably, eligible expenses for the
American opportunity credit include required course materials such as
books and supplies.

* If families have a Sec. 529 or
Coverdell education savings

A special individual retirement account opened on behalf of a child under age 18. Contributions of up to $2,000 annually may be made by anyone who meets specified income limits.
, they should consider using distributions to cover college room
and board, which are not eligible expenses for purposes of the credits
or deduction.

Joseph D. Beams ( is an associate professor of
accounting at the
University of New Orleans

. John W. Briggs
( is an associate professor of accounting at
Madison University

 in Harrisonburg, Va.

To comment on this article or to suggest an idea for another
article, contact Paul Bonner, senior editor, at or


JofA articles

* “Scholarships and Support,” May 2011, page 56

* “Rating 529 College Savings Plans,” Sept. 2006, page 45

Use to find past articles. In the search
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The Tax Adviser article

* “Dependency Exemption Issues for College Students,”
Aug. 2010, page 546

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* CPA Client Bulletin (#CB_FI12, #CB_FN 12, #CB_LN 12, #CB_IF12,
#CBDXXI 2 and #CBEXXI 2)

* CPA Client Tax Letter (#CTLFI12, #CTLFN 12, #CTLLF12, #CTLLN12
and #CTLDXXI 2)



* AICPA’s 1040 Tax Return Workshop by

 Kess (#735226)

* AICPA’s 2011 Individual Tax Review Series: Beyond the Basics

* AICPA’s 2011 Individual Tax Review Series:
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by Joseph D. Beams, CPA, PhD. and John W. Briggs, Ph.D.

Exhibit 1

Education Credits and Deduction Compared
(based on 2012 tax table)

                        American      Lifetime   Both       Tuition
                        opportunity   learning   credits    and fees
                        credit        credit                deduction

Salary                  $100,000      $100,000   $100,000   $100,000
Tuition and fees
deduction                      0             0          0    (4,000)
Adjusted gross income    100,000       100,000    100,000     96,000
Standard deduction      (11,900)      (11,900)   (11,900)   (11,900)
Personal exemptions     (15,200)      (15,200)   (15,200)   (15,200)
Taxable income            72,900        72,900     72,900     68,900
Tax                       10,285        10,285     10,285      9,465
American opportunity
credit                   (5,000)             0    (2,500)          0
Lifetime learning
credit                         0       (1,600)      (800)          0
Net tax                   $5,285        $8,685     $6,985     $9,465

Exhibit 2

Higher Education Tax Benefits Compared

Code sections        25A(i)              25A(c)

Benefit name         American            Lifetime
                     opportunity         learning credit

Benefit              Credit up to        Credit up to
                     $2,500 per          $2,000 per
                     student             taxpayer

Tuition and fees     Yes                 Yes

Books and supplies   Yes                 No

Now and board        No                  No

Phaseout   Single    $80,000-$90,000     $52,000-$62,000
range      Married   $160,000-$180,000   $104,000-$124,000

Code sections        222                117

Benefit name         Tuition and        Qualified
                     fees deduction     scholarship

Benefit              Deduction up       Excluded
                     to $4,000 per      from gross
                     taxpayer           income

Tuition and fees     Yes                Yes

Books and supplies   No                 Yes

Now and board        No                 No

Phaseout   Single    Phased out in      None
range      Married   steps; see text.

Code sections        529         530

Benefit name         Qualified   Coverdell ESA

Benefit              Tax-free    Tax-free
                     earnings    earnings

Tuition and fees     Yes         Yes

Books and supplies   Yes         Yes

Now and board        Yes         Yes

Phaseout   Single    None        $95,000-$110,000
range      Married               $190,000-$220,000
(for                             (for contributions)