Tax Planning, Huntington Beach, CA
Have tax questions? Ask the tax experts at Yorktown Main.
Our Tax Research Process
The Yorktown Main Advantage
Over 5 years of experience in the analysis and interpretation of tax laws
Meticulous research process involving thorough examination of the Internal Revenue Code & State Publications
Tax Planning Example:
John has contacted Yorktown Main with a seemingly straightforward question: “Will I be able to write off my daughter’s college tuition on my tax return?” John explains that his oldest child, Suzy, will be graduating from high school and will be attending UC San Diego in the fall. The tuition is $13,400 a year. He plans to take out a loan for half the amount and pay the rest in cash. He and his wife have a combined income of $140,000 and they will file jointly.
Most taxpayers would expect this question to have a simple “yes or no” answer. However, due to the complexity of the tax code, this is not the case. In order to provide John with a full understanding of the tax implications, an in-depth analysis is required. To arrive at the most comprehensive conclusion, we would employ our five-step tax research process:
Step 1: Establish the Facts
First, we need to gather all of the relevant facts. In this scenario, we would first identify the existing tax benefits for education. Currently, there are two tax credits available to help offset the costs of higher education. They are: the American opportunity credit (AOC) and the lifetime learning credit (LLC). In addition, there other types of tax benefits potentially available to John. These include a tuition and fees deduction, student loan interest deduction, as well as various tax-exempt savings plans.
In addition, we would take into consideration how John plans to pay for the tuition. For instance, if he decides to use funds from a tax-free savings plan, such as a Coverdell education savings account (ESA), this may affect the amount of education credit available to him.
Step 2: Locate & Evaluate the Authority
order to determine which education tax benefits are applicable to John, we must
consult the relevant state and/or federal tax code. This would require a
thorough review of IRS Tax Publication 970: Tax Benefits of Education, a 96
Step 3: Identify the Issues
Thirdly, we need to determine John’s eligibility for each tax benefit. Each tax credit and deduction have different eligibility requirements:
Tuition and Fees Deduction: This deduction is allowed for qualified education expenses paid during the year for your dependents, up to $4,000. You can take this deduction, even if you do not itemize deductions, on Schedule A (Form 1040). The limit on modified adjusted gross income (MAGI) is $160,000 if married filing a joint return and $80,000 if single, head of household, or qualifying widow(er).
American opportunity credit: Generally, you can claim up to a $2,500 credit per eligible student. The limit on modified adjusted gross income (MAGI) is $180,000 if married filing jointly and $90,000 if single, head of household, or qualifying widow(er). The eligible student must be pursuing a program leading to a degree or other recognized education credential.
Lifetime learning credit: Generally, you can claim up to a $2,000 credit per return. The limit of modified adjusted gross income (MAGI) is $128,000 if married filing jointly and $64,000 if single, head of household, or qualifying widow(er). The student does not need to be pursuing a program leading to a degree of other recognized education credential.
Student Loan Interest Deduction: Student loan interest is interest you paid during the year on a qualified student loan. Using this deduction, you may be able to reduce your income subject to tax by up to $2,500. The limit on modified adjusted gross income (MAGI) is $160,000 if married filing a joint return and $80,000 if single, head of household, or qualifying widow(er).
Step 4: Develop Conclusions
Given John’s income and filing status, he is eligible to take the tuition and fees deduction. Because the deduction is phased-out at higher income levels, he would only be eligible to take a portion of the deduction (up to $2,000). However, this deduction is most beneficial for those who do not qualify for the education credits.
A tax credit is generally preferable because it reduces your tax dollar-for-dollar, as opposed to a deduction, which simply reduces your taxable income. Since John’s daughter will be attending a four-year undergraduate program leading to a degree, he is eligible to take the American opportunity credit. John’s income of $140,000 makes him ineligible for the lifetime learning credit.
Since John is planning to pay for half of the education costs using student loans, he is also able to deduct the interest he pays on the loan during the year, as long as he has a qualified student loan. In order to be considered as such, the loan must be taken out solely to pay qualified education expenses on behalf of his daughter and cannot be made under a qualified employer plan. Also, because John’s income falls within a specific range, he cannot take the full $2,500 deduction. He must figure a reduced deduction by multiplying his interest deduction by a calculated fraction.
Step 5: Communicate Recommendation
The last step is to clearly communicate with our clients the best course of action given their individual situation. Recommendations will sometimes include alternative courses of action, especially if no single best answer is available.
In this scenario, we would advise John about the various education tax benefits available to him and his eligibility for each. Upon review of John’s financial information and the relevant tax code, we would conclude that it is most tax advantageous for him to take the American opportunity credit as well as the student loan interest deduction (after figuring the reduced deduction amount based on his MAGI).
Lastly, we would educate John regarding various education savings plans and tax avoidance strategies that may help him pay for his other children’s future education expenses. This may include establishing and contributing to a Coverdell education savings account (ESA), participating in a qualified tuition program (QTP) that features tax-free earnings, taking early distributions from an IRA for education costs, and/or cashing in a savings bond.
By utilizing the Yorktown Main research process, we are able provide our clients consistent and reliable advice. Generalized or “off-the-cuff” answers are often incomplete or inaccurate. We arm our clients with the information they need to make intelligent decisions that can ultimately save them thousands in taxes.