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Six Important Facts About the American Opportunity Tax Credit

Sep 26th, 2009
by jblankenship.
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7305361The IRS recently posted a tax tip (Tax Tip 2009-11) regarding the provisions of the American Opportunity Tax Credit, which was created as a part of ARRA 2009.

The six facts reported in the IRS notice are as follows:

  1. The American Opportunity Tax Credit, which expands and renames the existing Hope Credit, can be claimed for qualified tuition and related expenses that you pay for higher education in 2009 and 2010.  Qualified tuition and related expenses include tuition, related fees, books and other required course materials.
  2. The credit is equal to 100% of the first $2,000 spend and 25% of the next $2,000 per student each year.  Therefore, the full $2,500 credit may be available to a taxpayer who pays $4,000 or more in qualifying expenses for an eligible student.
  3. The full credit is generally available to eligible taxpayers who make less than $80,000 (single taxpayers) or $160,000 (married taxpayers filing jointly).  The credit is phased out gradually for taxpayers with incomes above these levels.
  4. 40% of the credit is refundable, so even if the taxpayer owes no tax he can receive up to $1,000 of the credit for each eligible student as a refund.
  5. The credit can be claimed for qualified expenses paid for any of the first four years of post-secondary education. (The previous Hope Credit was available only to students in the first two years of post-secondary education.)
  6. You cannot claim the tuition and fees deduction in the same year that you claim the American Opportunity Tax Credit or the Lifetime Learning Credit.  You must choose to either take the credit or the deduction, whichever is more beneficial to you.

Of course this changes the landscape of available tax credits and therefore the affordability of college for lots of folks.  If your situation is such that tax credits could make the difference between going to college or not, you should probably talk your situation over with your tax advisor.

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Tuition and Fees Deduction Expiring At The End Of 2009

Sep 18th, 2009
by jblankenship.
2 comments

12/17/2010 – with the passage of the Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, the rate changes formerly discussed in this article have been superseded.

Photo by L'Enfant Terrible ?

A Change (not for the better) For Illinois’ 529 Plans

Aug 29th, 2009
by jblankenship.
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In case you happened to miss it, the Illinois legislature last year passed an addition to the Revenue Code that requires recapture of deductions that you may have taken for contributions to one of the Illinois 529 plans.

u of queensland by Ryan Wick529 Contribution Deduction Recapture

For years, the Illinois 529 plans – BrightStart, Bright Directions, and College Illinois! – have allowed you to deduct up to $10,000 in contributions ($20,000 for a married couple) from your income as calculated for Illinois income tax.  At the present 3% rate, this can amount to a tax savings of up to $300 ($600 for a couple) per year.  Understandably, if you chose to transfer those funds to an out-of-state 529 plan, there has always been a recapture provision, requiring you to pay back the tax you saved when you deducted the funds.  That used to be the end of the story, but it was too good to be true, as is often the case with tax laws.

With this new change, in effect for tax year 2009, for any withdrawal from your Illinois-based 529 plan that is NOT for qualified education expenses, you are also required to recapture the tax offset.  It wasn’t unexpected.  If you think about it, the reason the deduction was originally put in place was to incent Illinois residents to set aside money for college.  Without this recapture (and the transfer recapture mentioned above) the overall affect of the incentive is disregarded.

All non-qualified withdrawals are subject to taxation on the growth component at the federal and state level, plus a 10% penalty.  In the past that was the only consideration you had to take into account with a non-qualified withdrawal.  For example, let’s say you had a 529 plan in Illinois with a contribution of $10,000, which had grown to a total of $15,000. When time for college came around, it turned out that your child didn’t want to go to college – she had a good paying job and didn’t plan to further her education.  So you decide to withdraw the funds from the 529 account to give her a “head start” on buying a home.  The growth component of the account, $5,000, is subject to ordinary income tax on your federal and state returns, plus a 10% penalty.  On top of that, you will have to include the original $10,000 contribution on your Illinois return as a part of your Illinois adjusted gross income.  So the taxation on your non-qualified withdrawal has the following effects:

Federal tax (25% example) on $5,000 growth = $1,250

Federal Penalty on $5,000 growth = $500

Illinois tax (3%) on $5,000 growth = $150

Recapture tax (3%) on original $10,000 deducted contribution = $300

Total = $1,250 + $500 + $150 + $300 = $2,200 = 14.66% of the non-qualified withdrawal of $15,000

It should be noted that, in the case of the death or disability of the beneficiary-student, the recapture, taxation and penalty do not apply, at the federal or state level.

As I said, this wasn’t unexpected, but it does represent a takeaway of what was a taxpayer-friendly component of the Illinois-based plans.  If you have questions on how this might impact you, please let me know.

Photo by Ryan Wick

Changes to Student Aid 7/1/2009

Jul 7th, 2009
by jblankenship.
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Every year on July 1, annual changes come into play in the education aid arena, and this year is no exception, with lots of changes.  As of July 1, 2009, several changes for Student Financial Aid went into effect.  Highlights are:

student in class by foundphotoslj

  • Increase in maximum Pell Grants to $5,350.  The old maximum amount for Pell Grants was $4,700, a number increased by the College Cost Reduction and Access Act (CCRAA) and the American Recovery and Reinvestment Act (ARRA).  The minimum Pell grant has been increased – in the past the minimum was $400, and now the minimum has been pegged at 10% of the appropriated maximum… so, to really confuse matters, the “appropriated maximum” for 2009-2010 is $4,860, with a CCRAA addition of $490 to all Pell awards (hence the maximum reported above of $5,350).  What this means is that the effective minimum for school year 2009-2010 is $976, which is $486 (10% of appropriated maximum) plus the CCRAA addition of $490.
  • New Subsidized Stafford Loans have a rate of 5.6%, on up to $5,500 (up from $3,500). This is the second of four annual cuts to the rate on these loans, which will continue until the rate reaches 3.4% in 2011.
  • Old loans are pegged to the 91-day T-Bill auction rate.  For now, that rate is an amazingly low 2.48%.  This applies to loans made before June 30, 2006 and after July 1, 1998.
  • Stafford Loan upfront fees have dropped to 1.5% from 2%.  If insurance is not added to the loan, the upfront fee is now as low as 0.5%.
  • New Income-Based Repayment program (IBR) is available to folks who are already paying back their loans.  This program caps borrowers’ monthly loan payments at 15% of their discretionary income (that is, 15% of what a borrower earns above 150% of the poverty level for their family size).  Any current or future borrower whose loan payment exceeds 15% of his or her discretionary income is eligible.  After 25 years in the program, the borrowers’ debts will be completely forgiven.  Borrowers with high debt or low-paying jobs are most likely to benefit from the program.  IBR applies to all federal loans made to students, including Stafford, Grad PLUS or consolidation loans, but not loans made to parents.  Perkins loans are also eligible if a borrower consolidates them into a FFEL or Direct loan.
  • Competitive Loan Auction Pilot Program, which was scheduled to begin on July 1, has been canceled due to lack of interest from FFELP lenders.
  • Sex offenders are no longer eligible to receive Pell Grants.
  • Due to the implementation of IBR, the old 20/220 ratio will no longer be in effect.  Under this old plan, a student could qualify for economic hardship deferment on their loans if they 1) are employed full time; 2) have an education loan debt burden equal to or greater than 20% of their monthly income; and 3) have an income minus debt burden that is less than 220% of the greater of the minimum wage rate or the federal poverty line for a family of two. This could be extended if HR 1615, Medical Economic Deferment for Students Act is passed.
  • The Higher Education Opportunity Act (HEOA) provides for maximum Pell Grant eligibility to a student whose parent or guardian was a member of the Armed Forces and died as a result of performing military service in Iraq or Afghanistan after 9/11/2001, provided that the child was under 24 years of age or was enrolled in college at the time of the parent or guardian’s death.
Photo by foundphotoslj

BrightStart / Oppenheimer Update

Jun 10th, 2009
by jblankenship.
2 comments

my-birthday-by-hamed-saberAs we previously discussed in this post, the Illinois State Treasurer, Alexi Giannoulias is taking Oppenheimer to task for it’s sins with regard to the BrightStart 529 plan, an Illinois-based college savings plan.  This is in regard to Oppenheimer’s use of inappropriately risky investments in a supposedly safe, bond-oriented, allocation for the plan.

Just recently, on June 8, reports from Giannoulias’ office indicate that families who lost portions of the estimated $85 million in these funds are likely to recover up to $77 million of the losses.  This is due to an agreement under way between Oppenheimer and Illinois.  Specific details are unknown at this point, but I thought it was important to keep you all updated.

Photo by Hamed Saber

Reminiscing…

Apr 24th, 2009
by jblankenship.
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5th-anniversary-spoon1Earlier this week marked the five year anniversary of this blog.  Seems like an awful lot has happened during that time, from many different points of view.  I thought it would be interesting to review a couple of those early entries today, to see how they have weathered the test of time.  Keep in mind, at that time the blog entries were solely reprints of my then-quarterly newsletter…

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A Look Back At Five-Year-Old Posts

First Message:  message is as relevant today as it was then.  We know who we are, we average everyday people, and this remains the folks that I work with.

Reallocating In 5 Easy Steps:  no amazing technological advances here – the process pretty much remains the same, and continues to be important.

TIDBITS - College Savings:  Talk about the good ol’ days!  I know personally that WIU at Macomb has increased considerably from those figures.  Here’s an update with the 2009 figures (amount of increase in percentage):

Southern Illinois U Carbondale:  $18,901 (+63%)
Bradley U: $30,410 (+33%)
Illinois State U:  $19,828 (+26%)
U of Illinois:  $23,150 (+47%)
Western Illinois U:  $16,037 (+73%)

Financial Planning 101: still as relevant today as it was when originally written.

I guess that’s all a good sign, right?  That the stuff we discussed here continues to be important and relevant five years later…?  Hopefully you’ve had a chance to implement some of those recommendations over the past five years and have reaped some rewards from them.

As with just about anything, there is no magical solution to always be successful and avoid all problems in your financial life – but hopefully what you’ve seen here over the years is helpful to improve your overall success-to-problem ratio in your favor.

Thanks for five years’ worth of listening – I’ll do my best to be worthy of your attention.  Please, no spoons or wood are necessary… :-) But do let me know (leave a comment) if you like something, hate something, or if you’d like to see other topics covered.

Illinois’ BrightStart Plan Woes

Apr 21st, 2009
by jblankenship.
1 comment
Note: an update to this story can be found here.

If you’re an Illinois (among other states, see Note below) parent of a child heading to college or already in college, then you may already be painfully aware of the “Oppenheimer problem” that the BrightStart 529 plan has encountered.

worcester-college-by-sba73Briefly, one of the Oppenheimer mutual fund choices (formerly) available as an allocation option in the BrightStart 529 plan (Illinois’ plan, see Note below for other plans affected) was the Champion Income fund.  Last fall, during the market downturn, this particular fund experienced a 79% freefall.  Another option, the Core Bond fund, experienced a 36% drop.  These are astounding numbers, given that peer funds only experienced an 8% drop during the same period.

These two funds are part of a grouping that is typically conservative in nature, not given to wild swings in the market (up or down) – and as such, parents who chose these funds as a part of their allocation for 529 savings were expecting a conservative growth diversifier when choosing these funds.  Unfortunately, Oppenheimer funds’ management had decided to drink the kool-aid of investing in the extremely risky mortgage security derivatives that have become the poster child of the economic meltdown we’ve been experiencing.

Thus far, Oppenheimer has admitted no wrongdoing, but rather has indicated that it acted appropriately in managing the funds.

Illinois Treasurer Alexi Giannoulias is leading an effort to resolve this situation, which reportedly has cost Illinois families as much as $85 million, by negotiating with Oppenheimer.  Thus far, Oppenheimer has admitted no wrongdoing, but rather has indicated that it acted appropriately in managing the funds.  Giannoulias has indicated that he will sue the company if negotiation is fruitless.

How We Can Keep This From Happening Again

The biggest issue here is that there is very little oversight into 529 plan fund management.  There are no federally-mandated cap on fees in these funds, and precious little oversight into the management of the funds.  Since these funds are not the same mutual funds that are publicly traded, there can be some funky things going on with fee structures and investment management that isn’t as clear to the individual investor.

I believe the time has come to give these funds the same oversight and require the same disclosure as all other security investments. It’s costly enough to pay for college – families who save in these plans should deserve to know that their investments are held to the same high standard as all other investments.

Note: While the Illinois BrightStart 529 plan has been the headliner lately, several other states’ 529 plans have been hammered by the same two Oppenheimer funds: Maine (NextGen), New Mexico (Scholar’s Edge and Education Plan), Oregon (Oregon College Savings and Oppenheimer 529), and Texas (LoneStar and Texas College Savings).  Legal action is pending for each state individually.

Education Benefits of ARRA 2009

Apr 20th, 2009
by jblankenship.
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16332570The American Recovery and Reinvestment Act of 2009 (ARRA 2009) included three provisions for higher education benefits:  changes to the HOPE education credit program, increases in the Pell Grant limits, and expansion of the types of expenses considered Qualified Higher Education Expenses for §529 college savings plans.

Changes to the HOPE Education Credit Program (renamed American Opportunity Tax Credit)

The American Opportunity Tax Credit is a re-vamp of the HOPE program, presently just for 2009 and 2010, and amounts to a credit of:

  • 100% of the first $2,000 of qualified tuition and related educational expenses, plus
  • 25% of the qualified tuition and related educational expenses over $2,000 but not more than $4,000

The maximum credit for tax years 2009 and 2010 is $2,500 (up from $1,800), and is allowed during the first four years (previously the first two years) of the student’s post-secondary education in a degree or certificate program.  For the purposes of this credit, the definition of qualified tuition and related educational expenses has been expanded to include course materials (previously excluded) in addition to tuition and fees.

Up to 40% of this credit can be refundable, unless the student is subject to kiddie-tax rules. The credit is phased out for single taxpayers with MAGI over $80,000, or married-filing-jointly filers with MAGI over $160,000.

Section 529 Plan QHEE Definition

Prior to ARRA 2009, the only way to pay for required computing equipment and services for higher education was via a Coverdell Education Savings Account.  ARRA 2009 changed the definition of Qualified Higher Education Expenses (QHEE) for §529 college savings plans to specifically include computers and computing equipment, plus internet access and related services.

This is a quite generous definition, including computing equipment and services as long as “such items are to be used by the beneficiary (of the §529 account) and the beneficiary’s family during any of the years that the beneficiary is enrolled at an eligible educational institution.”

Pell Grant

For tax year 2009, the maximum Pell Grant has been increased to $5,350, and for 2010 to $5,550, which represents an increase in the scheduled maximums of $500 for each period.

Higher Education Expenses Paid From A Qualified Plan

Apr 11th, 2009
by jblankenship.
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7305361

Another way to pull funds from an IRA or a qualified retirement plan (401(k), 403(b), 457, etc.) without having to pay the 10% penalty is to use those funds for Qualified Higher Education Expenses (QHEE).  This comes up quite often, as parents are faced with the issues surrounding the dueling requirements of retirement saving and paying for college for the young ‘uns.

We’ve been talking about the components of Internal Revenue Code Section 72, and specifically here we’re talking about §72(t)(2)(E).  In this portion of the code, the provision is made for a taxpayer qualified retirement plan or IRA owner to withdraw, without penalty, amounts “not to exceed the Qualified Higher Education Expenses for the tax year”.

So, you may ask, what is a QHEE? Essentially, this includes tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution.  Also included are expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance.

Room and board also qualifies, but only to the extent that it is not greater than the educational institution’s allowance for room and board, or the amount that the institution actually charges for room and board.  In addition, with the passage of the ARRA 2009, computing equipment and services (including internet service) can be included as QHEE, at least for 2009 and 2010 (likely to be extended).

Who is the student? For the purpose of this provision, the student can be the IRA account owner, her spouse, eligible children (generally dependents), and grandchildren.

Amounts withdrawn must be no more than the QHEE for the tax year, reduced by any additional tax benefits applied: 529 or Coverdell ESA account withdrawals; QHEE covered by HOPE or Lifetime Learning credits; or any grants or scholarships received.

Changes Coming For 529 Plans…?

Jan 30th, 2009
by jblankenship.
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It’s very likely, according to some sources, that 529 plans will be impacted by changes in the law in the coming months.  Among those changes are the great potential (included in the proposed stimulus plan) that you’ll soon be able to use your 529 plan proceeds to purchase computers and computing services – an option that formerly was only available in the Coverdell ESA plans.  Keep in mind that the proposed stimulus plan only impacts this law for 2009 and 2010, currently.

As well, there may be provisions brought forth to expand the current Saver’s Credit to include contributions to 529 plans; a possible change to the number of times a year that you are allowed to make changes to your allocations in a 529 plan (already temporarily changed to twice a year for 2009 from the former once annually); and then the downside potential: it’s very possible that the provisions of 529 plans may become more strict, as there is a lot of possible revenue left on the table for the Treasury with the current rules.

Stay tuned!

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