American Opportunity Tax Credit (formerly known as the Hope Scholarship Credit)-This is a maximum $2,500 tax credit available for the payment of qualified expenses to attend post secondary school in 2009 and 2010.  In order to take advantage of the full $2,500 tax credit it will be necessary to have $4,000 in qualified expenses.  The first $2,000 of qualified expenses will receive a dollar for dollar credit and the next $2,000 in qualified expenses will receive a credit for $.25 of each dollar.  This credit can be applied against one’s tax liability.  If there is little or no tax liability a refund can be issued for up to 40% ($1,000 maximum) of the estimated credit. 

Qualified Expenses-These expenses include tuition and certain related expenses required for enrollment or attendance at an eligible educational institution.  For the years 2009 to 2010 the costs for course materials or textbooks will also be considered a qualified expense.  

Income Limits-The phase-out and income limits for a single taxpayer start at $80,000 and are completely eliminated at $90,000.  For taxpayers filing a joint return the phase-out begins at $160,000 until the $180,000 maximum income level is reached.

 Qualified Tuition Program (529 Plan)-For the years 2009 to 2010 the definition of eligible expenses now include a computer, computer equipment, and internet access for a student and their families.  The typical qualified expenses include amounts paid for tuition, fees, books, supplies, and reasonable costs of room and board at an eligible educational institution.  In 2011 computers and computer equipment will not qualify unless they are required as a condition of enrollment or attendance. 

Coordination of Qualified Expenses-With the expansion of the tax credit under the American Opportunity Tax Credit this credit will use up more of the qualified expenses ($4,000) in taking advantage of the tax free benefit.  The same qualified expenses cannot be used for other tax savings.  This will result in fewer opportunities to take advantage of tax free distributions from a 529 plan.  If you combine this with the drop in the stock market, any 529 plans with an exposure to the stock market may have net losses and not gains.

 Work Study Programs-A total of $200 million will be spent on the work study program.  The federal work study program has been expanded so thousands of additional students will be part of the program.

 Pell Grants-Congress has made it easier for more students to qualify for Pell Grants through additional funding.  In addition, the rules for filing as an independent student will make it easier for many.  The maximum Pell Grant will increase to $5,350 for the 2009-2010 year, up from $4,731 for the 2008-2009 year .

Academic Competitiveness Grant and the National Smart Grant-By increasing the number of Pell Grant recipients more students will be able to qualify for the Academic Competitiveness Grant and the National Smart Grant.   The Academic Competitiveness Grant award is $750 for the first year and $1,300 for the second year. The maximum National Smart Grant is $4,000 in the third and fourth years of college.  In order to qualify the student must have a rigorous academic program in high school and pursuing a specific math or science field in college.

Additional Funding for the Colleges

Build America Bonds- The Build America Bonds will be taxable securities subsidized by the federal government.  Typically, tax-free bonds are issued by colleges and carry a lower rate than taxable bonds.  The lower interest rates are offset by the tax savings.  It is important to consider a taxable equivalent yield in making a decision.     

The subsidy would come in one of two ways.  Buyers would receive a tax credit equal to 35 percent on the interest payments or issuers would receive a subsidy from the federal government equal to 35 percent of the interest they are paying.

A college could have substantial savings by issuing Build America taxable bonds.  For example, if the bonds have a taxable market rate of 5 percent compared to a tax-free bond paying about 4 percent, the effective cost of borrowing would be 3.25 percent.

This is a question we hear all the time.  Let’s take a look at what a Qualified Tuition Plan (529 Plan) is and what the IRS says about the taxation of the plan.  According to the IRS, states may establish and maintain Qualified Tuition Plans, also called  529 plans, that allow parents to either prepay or contribute to an account to pay a student’s qualified education expenses at a post secondary institution.

What does the IRS say about the taxation of the plan?  According to the IRS, distributions from eligible educational institution QTPs may be tax free. You may not have to include as income a distribution from a QTP established and maintained by an eligible educational institution.  If the IRS uses the words “may be” in a sentence, it may be time to look a little deeper at this.

Let’s take a look at what may cause the 529 plan to be taxable. According to the IRS, you must compare the total of all QTP distributions for the tax year to the adjusted qualified education expenses to determine if total distributions for the year are more or less than the amount of qualified education expenses.  Adjusted qualified education expenses are the total total qualified education expenses less any tax-free educational assistance.

Tax-free educational assistance includes:

• The tax-free part of scholarships and fellowships
• Veterans’ educational assistance
• Pell grants
• Employer-provided educational assistance
• Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational   assistance

It appears that if you plan on paying the entire college bill (without financial assistance) using the 529 plan, it will likely be tax-free.  If you plan on applying for scholarships, you should ask a few questions.  If you’re seeking any financial aid or other educational assistance from the university, you’ll need to find out more.  Don’t make the mistake of assuming all of the distributions will be tax-free.

For additional details, take a look at IRS Publication 970.

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