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Study up on tax breaks for education

By HELEN HUNTLEY, Times Staff Writer

© St. Petersburg Times
published February 16, 2003

In their eagerness to help parents pay for college educations, federal lawmakers have created a perplexing maze of tax credits, deductions and exclusions from income. Figuring out which ones taxpayers might actually be able to use this year will be a bigger challenge than ever.

The 2002 returns provide the first opportunity to claim a new $3,000 deduction for tuition and fees and to take advantage of tax-free withdrawals from the Florida Prepaid College Plan. Rules on deducting student loan interest also have changed a bit. And Coverdell Education Savings Accounts, formerly known as Education IRAs, have been expanded.

But when taxpayers actually crunch the numbers, many are going to be disappointed by the size of their benefits, if they qualify for any at all.

For starters, any expenses paid for by a tax-free scholarship cannot be used to claim the education tax breaks. If a Florida Bright Futures Scholarship covers 75 percent of the student's tuition and fees, only the remaining 25 percent is a qualifying educational expense. For typical full-time students at the University of South Florida, that leaves a little more than $600 that might be deductible if they don't get other scholarships. Many of the best tax breaks, including the new deduction, apply only to tuition and fees.

The new deduction has some great features. It can be taken even if you don't itemize. And you can get a full deduction with joint income up to $130,000, a much higher threshold than some of the other tax breaks. But once they run the numbers, many parents will discover they are better off using their tuition expenses to claim the Hope Credit or the Lifetime Learning Credit if they are eligible. If you claim one of those credits, you cannot take the new deduction.

For many Floridians, the best of the new benefits may be the change in the law that made withdrawals from the Florida Prepaid College Plan, and other so-called 529 college savings plans, tax free. In the past, these accounts were tax deferred, with taxes due on the interest earnings when the money was withdrawn. Books, supplies, equipment and room and board all are considered qualifying expenses, so the tax-free benefits apply even if Bright Futures covers all or most of your tuition. In addition, this is one of the few tax breaks for which there are no income limits to qualify.

All of the tax breaks except the Hope Credit can be used for both undergraduate and graduate expenses. The Hope Credit is limited to the first two years of college and can be taken only two years.

In addition to paying college expenses, withdrawals from the Coverdell Education Savings Account can be used tax free to pay for tuition, tutoring, uniforms, transportation and other expenses for students in kindergarten through 12th grade.

Families also are permitted to sock away more money in education savings accounts. The annual limit on contributions has been increased to $2,000, and families have until April 15 to make a 2002 contribution.

The student loan interest deduction has been expanded. Previously only the first 60 months of interest payments on a loan were deductible. That limitation has been dropped.

More details about the education tax breaks can be found in IRS Publication 970, Tax Benefits for Education.

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