There are several opportunities and strategies for
education incentives and credits available in the US tax
code. The one I will discuss in this article is the
Coverdell ESA, formerly the Education IRA.
Code Sec.530 authorizes the Coverdell ESA as an education
savings account and can be set up as a trust or custodial
account for a designated beneficiary. In 2002 this program
was expanded so that it can now be used to finance
elementary and secondary education expenses.
You can open a Coverdell ESA for any designated beneficiary
child that you wish. The child only has to be under the age
of 18. So you could designate your child, a relative or
just anybody, it does not matter.
There are contribution limits in place though. There is a
$2,000 aggregate contribution limit per year on behalf of
any designated beneficiary. This means that if more than
$2,000 is contributed per child, the amount over $2,000 is
treated as an excess contribution. So if you contribute
$2,000 and someone else contributes $600, then $600 would
be treated as an excess contribution. There is a 6% penalty
if the excess contribution amount is not withdrawn from the
designated beneficiary's account by the due date of the tax
return.
One other important note here is that all contributions
must be made in cash. Property such as stocks is not
allowed.
In addition to the above-mentioned rules, there are
contribution limits on the contributor. You may make a full
contribution only if your modified adjusted gross income
(MAGI) is not more than $190,000 on a joint return, and
$95,000 if you file a single return. If your MAGI is above
these figures, then the contribution limit phase-outs for a
joint return are between $190,000 and $220,000, and for a
single return between $95,000 and $110,000.
Now that we discussed contribution rules for Coverdell
ESAs, let us move on to the taxation rules.
The earnings of Coverdell ESA investments are not subject
to tax when earned and distributions are excludable form
income of the beneficiary, but only to the extent that they
do not exceed qualified education expenses incurred during
the year the distributions are made. The definition of
qualified education expenses would be tuition, fees and
room and board if the beneficiary is enrolled on an at
least half-time basis. Room and board would mean the posted
rate by the school, or if the student lives off campus (but
not at home), then the amount is fixed at $2,500. As far as
tuition goes, even part time attendance would make tuition
a qualified higher education expense.
As I mentioned earlier, even elementary and secondary
education expenses are include. This would include
parochial school tuition and other expenses such as
uniforms, transportation and extended day care programs.
Also included is Computer technology expenses such as
Internet service. On occasion a beneficiary might take a
distribution for reasons other than education. If this
should happen, then the portion of the distribution that
represents earnings that have accumulated tax-free in the
account would be taxable. A 10% penalty would also apply to
such nonqualified distributions, with the following
exceptions; disability, death or receipt of a scholarship
by the beneficiary. Also an exception applies in the case
of military service academy appointments.
Distributions may also be rolled over tax-free to another
Coverdell ESA for the same beneficiary, or for certain
other designated beneficiaries such as step-children,
parents, siblings and their children, children of the
beneficiary, step-parents, grandparents, and spouses of
these people. There is a 60 day rollover period that
applies.
If the earning portion of a Coverdell ESA has not been used
for qualified higher education expenses by the time the
beneficiary reaches the age of 30, and the earnings portion
has not been rolled over to an eligible designated
beneficiary, then at that time the earnings portion would
be treated as a distribution.
Coverdell Education Savings Accounts can be used as an
important part of your strategy to help with education
expenses. They work best when used in conjunction with
other opportunities and strategies allowed. I encourage you
to educate yourself and then use all the available
opportunities that fit your situation.
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Steve Jackson is a professional income tax preparer with
over twenty years experience, helping clients with their
individual tax situations. Steve offers tax services and if
you file online, he can be here to help you with your tax
situation, and will provide you with free updates during
the year. Contact Steve at http://www.jjackson328.com
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