Here’s a brief rundown of ten tax tips you need to know to stay at the head of the class:
- Saving isn’t just for college. We tend to assume that savings plans only benefit students in college. Today, however, there is an array of plans available to help you pay for college – including the often overlooked Coverdell education savings account (ESA). With a Coverdell ESA, you can pay educational expenses for students in kindergarten through 12th grade, college or trade school – and it doesn't matter if your child attends a public, private or parochial school. Eligible expenses include tuition and fees as well as books, supplies, and equipment. Expenses also may include academic tutoring; special needs services; room and board; uniforms; and transportation. Money that you (or others, like grandparents) contribute to the plan will grow federal income tax free and assuming that you follow the rules, funds which are withdrawn and used for qualifying education expenses won’t cost you a penny in federal income tax.
- Credits are almost always better than deductions. Credits are great because they are dollar for dollar reductions in your taxes due as opposed to deductions which merely reduce your income subject to tax. Additionally, while it’s rare that you benefit from a deduction when there’s no tax owed, with some credits, you can actually get money back even if you don’t owe any tax. When it comes to credits for educational expenses, there are two that you should know about for 2013: The American Opportunity Credit (the souped up Hope Credit), worth up to $2,500 per eligible student and the Lifetime Learning Credit, worth up to $2,000. Limitations and exceptions apply but if you qualify, you can save thousands of dollars.
- “Free” isn't always free. Scholarships, fellowships and grants feel like “free money” and, as such, the assumption tends to be that the money is likewise federal income tax free. That’s not always true. Whether scholarships, fellowships and grants are federal income tax free will depend on a number of factors including what the funds can be used for and whether or not you’re pursuing a degree. The easy rule is that a scholarship, fellowship or grant is tax free only if you are pursuing a degree at an eligible educational institution and you use the funds to pay qualified education expenses; if you are not pursuing a degree, the full amount is subject to tax. Other amounts subject to tax would include those funds tied to services (such as teaching) and prizes.
- Kids pay taxes, too. A child who is a dependent and is under the age of 18, or under the age of 24 while a full time student, can earn up to $1,000 in unearned income (like interest and dividends) income tax free for 2013 for federal purposes; a child under that threshold does not have to file a federal income tax return. After that threshold, however, a child must pay tax at their own income tax rate on unearned income up to $2,000. Unearned income over $2,000 is taxed at the child’s parents’ tax rate. Income which is taxed at the child’s parents’ tax rate does not necessarily mean that the income has to be included on the parents’ tax return; the child can opt to file a separate return (and in fact, that can sometimes be preferable for all kinds of reasons, including the dreaded AMT).
The rules are different for earned income: any salary or wages that a child earns through full- or part-time employment are not subject to the kiddie tax rules and is taxed at the child’s tax rate. If income is earned and it is less than $5,700, there’s no need for that child to file a federal income tax return (a quick caution, though, that if a taxpayer is subject to SE tax, the threshold is generally $400 of net earnings); tips are also considered earned income. - You don’t always have to itemize in order to deduct your education-related expenses. The word “deduction” is almost always associated with “itemized” in today’s tax lingo – but that isn't always accurate. There are a number of deductions which are treated as adjustments to income, meaning that they are deducted from gross income without regard to any tax schedules (like the ever popular Schedule A). Since those deductions are found on the front page, they’re often referred to as “above the line” deductions. Popular above the line deductions related to education include the educator expense, the student loan interest deduction, the tuition and fees deduction and for some new grads, moving expenses.
- Uniforms – no matter how ugly – are never deductible. The IRS does not allow deductions for school uniforms for public, parochial or private schools even if uniforms are required – and even if you could prove that you’d never, ever wear them outside of school. They are considered a personal expense and not deductible. However, the rules are different for students who attend military school; while you still may not deduct the cost of your uniforms, you can deduct the cost of insignia, shoulder boards, and related items. Faculty and staff get a bigger break: under the rules, you can deduct the cost of your uniforms if you are a civilian faculty or staff member of a military school.
- It doesn't hurt to file. April 15 is often a scary day for taxpayers who fear writing out those big checks. Statistically, however, about half of taxpayers owe no tax – and some are actually due a refund. This can be especially true if you’re a student: due to refundable credits like the Earned Income Tax Credit and the American Opportunity Credit, you may qualify for a refund even if you don’t owe any tax. However, you can’t receive a refund if you don’t file. Even if you don’t meet the filing thresholds for your age and filing status, you should run the numbers to see if you come out ahead.
- Time is money, except when it comes to deductions. The Internal Revenue Service will never allow you to deduct the value of your time – even if you can clearly value that time in terms of dollars. However, if you’re spending time volunteering for a qualified charitable organization, related out of pocket expenses are deductible on your Schedule A as a charitable deduction so long as you itemize. Keep good records, including receipts; the same rules apply for the donations of goods for charitable purposes.
- Take advantage of employer-provided benefits: it’s free money.While fringe benefits offered by your employer are generally taxable, there are a few valuable exceptions under the Tax Code. With employer-offered educational assistance benefits, for example, you can claim up to $5,250 in tax free dollars used to pay for educational expenses even if you’re not pursuing a degree. Other useful employer-related benefits include reimbursements for commuting expenses – especially beneficial since commuting is never tax deductible – and health care benefits for children who are no longer minors but are still in school. Additionally, if your former boss used to be Uncle Sam, you may qualify for the G.I. Bill and other perks.
- What you can’t do one way, do another way. Sometimes, expenses don’t fall into the neat little categories we expect them to. But just because an expense won’t qualify as one kind of deduction or credit doesn't mean that it won’t qualify for another. Consider sports lessons and other after school activities like dance or music, as well as tutoring: while these expenses would not normally be deductible as mere instruction, they might be deductible as child care expenses. Music lessons might also qualify as a medical expense – the IRS allowed a deduction for clarinet lessons in 1962 when prescribed by an orthodontist to help correct an overbite. And similarly, while food is not normally deductible, the cost of a special diet might fly as a medical expense. Re-characterizing expenses can be smart but it can also be tricky – be sure to check with your tax professional for specific guidance.
Enjoy the new school year! Questions? As always, we are here to help! Give us a call today!
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