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College Savings & Taxes

There are more ways to save for college than taking a paper route. While you're busy getting up at the crack of dawn and learning the value of hard work, don't forget to also take advantage of every government-sponsored opportunity to defray the cost of higher ed. Check out these tax credits, deductions, and college savings plans, all of which can help your family foot the bill for college.

Tax-Advantaged College Savings
If you're lucky enough to have a "college fund," we hope you've got more than a traditional savings account. With tax-advantaged savings opportunities like these, you'll get even more bang for your buck.

Education Savings Bonds. If your family has Series EE and I Bonds that were issued after 1989, you won't pay taxes on any interest earned when you redeem them to pay tuition. The catch: The bonds must be registered in one of your parent's names to qualify for the tax exclusion - bonds issued in your own name aren't eligible. 

Mutual Funds. If your parents invested in a 529 plan or a Coverdell Education Savings Account (ESA) for your education, you can cash in big time. All the money you withdraw for qualified higher education expenses is tax free.

Tax Credits for College
Tax credits reduce the amount of income tax you owe, which is always a plus. Currently, the IRS offers two credits for education, though you can't claim both in the same year.

Lifetime Learning Credit. With this credit, you can get up to $2,000 per year, every year you're enrolled in school.

American Opportunity Credit. This new program (it modifies the Hope credit) offers up to a $2,500 credit every year for four years of your higher education. Generally, 40 percent of the credit is refundable, which means that your parents can still receive up to $1,000 each year - even if they don't owe any taxes.

More Tax Breaks for Education
While tax credits reduce the amount of income tax you have to pay, deductions, exemptions, and exclusions reduce the amount of your income that is taxable. You can only claim these deductions if you don't take an education tax credit in the same year.

Tuition Assistance. If you're getting tuition assistance from your employer, you can exclude up to $5,250 of those benefits each year. In other words, you won't have to pay tax on that money.

Student Loan Interest Deduction. Each year, you can deduct up to $2,500 of the student loan interest you've paid that year. The student loan interest deduction is taken as an adjustment to income, meaning the deduction will reduce the amount of income that's subject to taxation.

Tuition and Fees Deduction. This benefit, which has been extended through 2011, allows you to claim a deduction of up to $4,000 per year for your higher education expenses. This deduction is also taken as an adjustment to income.

Ask your parents to consult with a financial professional to choose the financial strategies that will translate into the lowest tax for your family. And remember this handy equation:

Proud parents + less financially strapped students = win-win situation!


 

Learn how to make the most of every tax break for education:

>> Get the lowdown on education savings bonds.

>> Research and compare 529 plans.

>> Check out this college savings plan comparison chart.

>> Get the nitty-gritty on the tuition and fees deduction.

>> Go to the source (the IRS).



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