Interactive Review
Course #10074
Tax Benefits for Higher Education
1A. True – Incorrect Return
A scholarship or fellowship is tax free only if:
1. You are a candidate for a degree at an eligible educational institution, and
2. You use the scholarship or fellowship to pay qualified education expenses.
A scholarship is generally an amount paid or allowed to, or for the benefit of, a student at an educational institution to aid in the pursuit of studies. The student may be either an undergraduate or a graduate. A fellowship is generally an amount paid for the benefit of an individual to aid in the pursuit of study or research. Generally, taxability depends on the expense paid with the amount and whether you are a degree candidate.
Qualified education expenses. For purposes of tax-free scholarships and fellowships, these are expenses for:
• Tuition and fees required to enroll at or attend an eligible educational institution, and
• Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution. These items must be required of all students in your course of instruction. However, in order for these to be qualified education expenses, the terms of the scholarship or fellowship cannot require that it be used for other purposes, such as room and board, or specify that it cannot be used for tuition or course-related expenses.
Qualified education expenses do not include the cost of:
• Room and board,
• Travel,
• Research,
• Clerical help, or
• Equipment and other expenses that are not required for enrollment in or attendance at an eligible educational institution.
1B. False – Correct Return
If you are a candidate for a degree at an eligible educational institution, and you use the scholarship or fellowship to pay qualified education expenses, your scholarship or fellowship is tax free. You are a candidate for a degree if you:
1. Attend a primary or secondary school or are pursuing a degree at a college or university, or
2. Attend an accredited educational institution that is authorized to provide:
a. A program that is acceptable for full credit toward a bachelor’s or higher degree, or
b. A program of training to prepare students for gainful employment in a recognized occupation.
An eligible educational institution is one that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities.
2A. True – Incorrect Return
If you are eligible to claim the Hope credit and you are also eligible to claim the lifetime learning credit for the same student in the same year, you can choose to claim either credit, but not both. For 2006, if the total qualified education expenses for a student are less than $7,500, it will generally be to your benefit to claim the Hope credit. If you pay qualified education expenses for more than one student in the same year, you can choose to take credits on a per-student, per-year basis. This means that, for example, you can claim the Hope credit for one student and the lifetime learning credit for another student in the same year.
2B. False – Correct Return
You can choose to claim either credit, but not both, if you are eligible to claim the Hope credit and you are also eligible to claim the lifetime learning credit for the same student in the same year. You may be able to claim a Hope credit of up to $1,500 for qualified education expenses paid for each eligible student. A tax credit reduces the amount of income tax you may have to pay. Unlike a deduction, which reduces the amount of income subject to tax, a credit directly reduces the tax itself. The Hope credit is a nonrefundable credit. This means that it can reduce your tax to zero, but if the credit is more than your tax the excess will not be refunded to you. The Hope credit you are allowed may be limited by the amount of your income and the amount of your tax.
3A. True – Correct Return
The amount of your Hope credit is phased out (gradually reduced) if your 2006 modified adjusted gross income (MAGI) is between $45,000 and $55,000 ($90,000 and $110,000 if you file a joint return). You cannot claim a Hope credit if your MAGI is $55,000 or more ($110,000 or more if you file joint return).
3B. False – Incorrect Return
If your MAGI is $55,000 or more ($110,000 or more if you file joint return) you cannot claim a Hope credit. For most taxpayers, MAGI is adjusted gross income (AGI) as figured on their federal income tax return. If you file Form 1040A, your MAGI is the AGI on line 22 of that form. If you file Form 1040, your MAGI is the AGI on line 37 of that form, modified by adding back any:
1. Foreign earned income exclusion,
2. Foreign housing exclusion,
3. Exclusion of income for bona fide residents of American Samoa, and
4. Exclusion of income from Puerto Rico.
If your MAGI is within the range of incomes where the credit must be reduced, you will figure your reduced credit using lines 8–14 of Form 8863.
4A. True – Incorrect Return
There is no limit on the number of years for which you can claim a lifetime learning credit based on the same student’s expenses. However, for the Hope credit you can claim for no more than 2 years the credit based on the same student’s expenses.
4B. False – Correct Return
The number of years for which you can claim a lifetime learning credit based on the same student’s expenses is unlimited. Generally, you can claim the lifetime learning credit if all three of the following requirements are met.
1. You pay qualified education expenses of higher education.
2. You pay the education expenses for an eligible student.
3. The eligible student is either yourself, your spouse, or a dependent for whom you claim an exemption on your tax return.
You cannot claim the lifetime learning credit for 2006 if any of the following apply.
• Your filing status is married filing separately.
• You are listed as a dependent in the Exemptions section on another person’s tax return (such as your parents’).
• Your modified adjusted gross income (MAGI) is $55,000 or more ($110,000 or more in the case of a joint return).
• You (or your spouse) were a nonresident alien for any part of 2006 and the nonresident alien did not elect to be treated as a resident alien for tax purposes.
• You claim the Hope credit or a tuition and fees deduction for the same student in 2006.
5A. True – Correct Return
Generally, personal interest you pay, other than certain mortgage interest, is not deductible on your tax return. However, if your modified adjusted gross income (MAGI) is less than $65,000 ($135,000 if filing a joint return) there is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return before subtracting any deduction for student loan interest. This deduction can reduce the amount of your income subject to tax by up to $2,500 in 2006.
5B. False –Incorrect Return
There is a special deduction allowed for paying interest on a student loan (also known as an education loan) used for higher education, if your modified adjusted gross income (MAGI) is less than $65,000 ($135,000 if filing a joint return). The student loan interest deduction is taken as an adjustment to income. This means you can claim this deduction even if you do not itemize deductions on Schedule A (Form 1040). Student loan interest is interest you paid during the year on a qualified student loan. It includes both required and voluntary interest payments. Qualified education expenses for purposes of the student loan interest deduction, are the total costs of attending an eligible educational institution, including graduate school. They include amounts paid for the following items.
1. Tuition and fees.
2. Room and board.
3. Books, supplies, and equipment.
4. Other necessary expenses (such as transportation).
The cost of room and board qualifies only to the extent that it is not more than the greater of the following two amounts.
1. The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid
purposes) for a particular academic period and living arrangement of the student.
2. The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.
6A. True – Incorrect Return
Generally, if you are responsible for making loan payments, and the loan is canceled (forgiven), you must include the amount that was forgiven in your gross income for tax purposes. However, if your student loan is canceled, you may not have to include any amount in income. Student loan repayments provided under certain federal and state repayment programs are tax free. If you fulfill certain requirements, two types of student loan assistance may be tax-free. The types of assistance are:
• Student loan cancellation, and
• Student loan repayment assistance.
6B. False – Correct Return
If your student loan is canceled, you may not have to include any amount in your gross income for tax purposes. To qualify for tax-free treatment, your loan must contain a provision that all or part of the debt will be canceled if you work:
• For a certain period of time,
• In certain professions, and
• For any of a broad class of employers.
The loan must have been made by a qualified lender to assist the borrower in attending an eligible educational institution. Qualified lenders include the following.
1. The government—federal, state, or local, or an instrumentality, agency, or subdivision thereof.
2. A tax-exempt public benefit corporation that has assumed control of a state, county, or municipal hospital and whose employees are considered public employees under state law.
3. An eligible educational institution, if the loan is made:
a. As part of an agreement with an entity described in (1) or (2) under which the funds to make the loan were provided to
the educational institution, or
b. Under a program of the educational institution that is designed to encourage its students to serve in occupations with unmet
needs or in areas with unmet needs where the services required of the students are for or under the direction of a
governmental unit or a tax-exempt section 501(c)(3) organization.
7A. True – Correct Return
You cannot claim the tuition and fees deduction if any ofthe following apply.
• Your filing status is married filing separately.
• Another person can claim an exemption for you as a dependent on his or her tax return. You cannot take the deduction even if the other person does not actually claim that exemption.
• Your modified adjusted gross income (MAGI) is more than $80,000 ($160,000 if filing a joint return).
• You were a nonresident alien for any part of the year and did not elect to be treated as a resident alien for tax purposes.
• You or anyone else claims a Hope or lifetime learning credit in 2006 with respect to expenses of the student for whom the qualified education expenses were paid.
7B. False – Incorrect Return
You cannot claim the tuition and fees deduction if your modified adjusted gross income (MAGI) is more than $80,000 ($160,000 if filing a joint return). In 2006, the amount of qualified education expenses you may take into account in figuring your tuition and fees deduction is $4,000 if your modified adjusted gross income (MAGI) is not more than $65,000 ($135,000 if you are married filing jointly). If your MAGI is larger than $65,000 ($135,000), but is not more than 80,000 ($160,000 if you are married filing jointly), your maximum tuition and fees deduction is $2,000. No tuition and fees deduction is allowed if your MAGI is larger than 80,000 ($160,000).
8A. True – Incorrect Return
Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed. If, for a year, distributions from an account are not more than a designated beneficiary’s qualified education expenses at an eligible educational institution, the beneficiary will not owe tax on the distributions. Qualified Education Expenses are expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution. For purposes of Coverdell ESAs, the expenses can be either qualified higher education expenses or qualified elementary and secondary education expenses. Designated beneficiary is the individual named in the document creating the trust or custodial account to receive the benefit of the funds in the account. For purposes of Coverdell ESAs, an eligible educational institution can be either an eligible postsecondary school or an eligible elementary or secondary school. Eligible elementary or secondary school is any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law.
8B. False – Correct Return
Amounts deposited in a Coverdell ESA grow tax free until distributed, however,
contributions to the account are not deductible. A Coverdell ESA is a trust or custodial account created or organized in the United States only for the purpose of paying the qualified education expenses of the designated beneficiary of the account. When the account is established, the designated beneficiary must be under age 18 or a special needs beneficiary. To be treated as a Coverdell ESA, the account must be designated as a Coverdell ESA when it is created. The document creating and governing the account must be in writing and must satisfy the following requirements.
1. The trustee or custodian must be a bank or an entity approved by the IRS.
2. The document must provide that the trustee or custodian can only accept a contribution that meets all of the following conditions.
a. Is in cash.
b. Is made before the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary.
c. Would not result in total contributions for the year (not including rollover contributions) being more than $2,000.
3. Money in the account cannot be invested in life insurance contracts.
4. Money in the account cannot be combined with other property except in a common trust fund or common investment fund.
5. The balance in the account generally must be distributed within 30 days after the earlier of the following events.
a. The beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary.
b. The beneficiary’s death.
9A. True – Incorrect Return
Beginning in 2005, you may not have to include in income a distribution from a QTP established and maintained by an eligible educational institution. States may establish and maintain programs that allow you to either prepay or contribute to an account for paying a student’s qualified education expenses. Eligible educational institutions may establish and maintain programs that allow you to prepay a student’s qualified education expenses. If you prepay tuition, the student (designated beneficiary) will be entitled to a waiver or a payment of qualified education expenses. You cannot deduct either payments or contributions to a QTP. For information on a specific QTP, you will need to contact the state agency or eligible educational institution that established and maintains it.
9B. False – Correct Return
You may not have to include in income a distribution from a QTP established and maintained by an eligible educational institution, beginning in 2004. A qualified tuition program (also known as a 529 plan or program) is a program set up to allow you to either prepay, or contribute to an account established for paying, a student’s qualified education expenses at an eligible educational institution. QTPs can be established and maintained by states (or agencies or instrumentalities of a state) and eligible educational institutions. The program must meet certain requirements. Your state government or the eligible educational institution in which you are interested can tell you whether or not they participate in a QTP. Qualified education expenses are the tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution They also include the reasonable costs of room and board for a designated beneficiary who is at least a half-time student. The cost of room and board qualifies only to the extent that it is not more than the greater of the following two amounts.
1. The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid
purposes) for a particular academic period and living arrangement of the student.
2. The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution. You will need to contact the eligible educational institution for qualified room and board costs.
10A. True – Correct Return
You may be able to take distributions from your IRAs for qualified education expenses without having to pay the 10% additional tax. However, you may owe income tax on at least part of the amount distributed. The part not subject to the additional tax is generally the amount of the distribution that is not more than the adjusted qualified education expenses for the year. Qualified education expenses for purposes of the 10% additional tax are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution. They also include expenses for special needs services incurred by or for special needs students in connection with their enrollment or attendance.
10B. False – Incorrect Return
Generally, if you take a distribution from your IRA before you reach age 59 ½ , you must pay a 10% additional tax on the early distribution. This applies to any IRA you own, whether it is a traditional IRA (including a SEP-IRA), a Roth IRA, or a SIMPLE IRA. The additional tax on an early distribution from a SIMPLE IRA may be as high as 25%. However, you can take a distribution from your IRA before you reach age 59 ½ and not have to pay the 10% additional tax if, for the year of the distribution, you pay qualified education expenses for:
• yourself,
• your spouse, or
• your or your spouse’s children or grandchildren.
11A. True – Correct Return
You may be able to cash in qualified U.S. savings bonds without having to include in your income some or all of the interest earned on the bonds if you meet the following conditions.
• You pay qualified education expenses for yourself, your spouse, or a dependent for whom you claim an exemption on your
return.
• Your modified adjusted gross income (MAGI) is less than $78,100 ($124,700 if filing a joint return).
• Your filing status is not married filing separately.
11B. False – Incorrect Return
Generally, you must pay tax on the interest earned on U.S. savings bonds. If you do not include the interest in income in the years it is earned, you must include it in your income in the year in which you cash in the bonds. However, when you cash in certain savings bonds under an education savings bond program, you may be able to exclude interest from income.
A qualified U.S. savings bond is a series EE bond issued after 1989 or a series I bond. The bond must be issued either in your name (as the sole owner) or in the name of both you and your spouse (as co-owners). The owner must be at least 24 years old before the bond’s issue date. The issue date is printed on the front of the savings bond.
12A. True – Incorrect Return
If you receive educational assistance benefits from your employer under an educational assistance program, you can exclude up to $5,250 of those benefits each year. This means your employer should not include the benefits with your wages, tips, and other compensation shown in box 1 of your Form W-2. This also means that you do not have to include the benefits on your income tax return. You cannot use any of the tax-free education expenses paid for by your employer as the basis for any other deduction or credit, including the Hope credit and the lifetime learning credit.
12B. False – Correct Return
You can exclude up to $5,250 of educational assistance benefits each year from your employer under an educational assistance program. This means that you do not have to include the benefits on your income tax return and your employer should not include the benefits with your wages, tips, and other compensation shown in box 1 of your Form W-2. To qualify as an educational assistance program, the plan must be written and must meet certain other requirements. Your employer can tell you whether there is a qualified program where you work. Tax-free educational assistance benefits include payments for tuition, fees and similar expenses, books, supplies, and equipment. Payments may be for either undergraduate- or graduate-level courses. The payments do not have to be for work-related courses. Educational assistance benefits do not include payments for the following items.
1. Meals, lodging, or transportation.
2. Tools or supplies (other than textbooks) that you can keep after completing the course of instruction.
3. Courses involving sports, games, or hobbies unless they:
a. Have a reasonable relationship to the business of your employer, or
b. Are required as part of a degree program.
13A. True – Incorrect Return
This chapter discusses work-related education expenses that you may be able to deduct as business expenses. To claim such a deduction, you must:
1. Be working,
2. Itemize your deductions on Schedule A (Form 1040) if you are an employee,
3. File Schedule C (Form 1040) or Schedule F (Form 1040) if you are self-employed, and
4. Have expenses for education that meet the requirements as Qualifying Work-Related Education.
If you are an employee and able to itemize your deductions, you may be able to claim a
deduction for the expenses you pay for your work-related education. Your deduction will be the amount by which your qualifying work-related education expenses plus other job and certain miscellaneous expenses is greater than 2% of your adjusted gross income. An itemized deduction reduces the amount of your income subject to tax. If you are self-employed, you deduct your expenses for qualifying work-related education directly from your self-employment income. This reduces the amount of your income subject to both income tax and self-employment tax. Your work-related education expenses may also qualify you for other tax benefits, such as the tuition and fees deduction and the Hope and lifetime learning credits. You may qualify for these other benefits even if you do not meet requirements listed above. Also, keep in mind that your work-related education expenses may qualify you to claim more than one tax benefit. Generally, you may claim any number of benefits as long as you use different expenses to figure each one. When you figure your taxes, you may want to compare these tax benefits so you can choose the method(s) that give you the lowest tax liability. First, figure your taxes using the expenses as business deductions. Then, figure your taxes again using any of the other deductions and credits for which you qualify. You may find that a combination of credit(s) and deduction(s) gives you the lowest tax.
13B. False – Correct Return
You may be able to claim a deduction for the expenses you pay for your work-related
Education, if you are an employee and able to itemize your deductions. Your deduction will be the amount by which your qualifying work-related education expenses plus other job and certain miscellaneous expenses is greater than 2% of your adjusted gross income. An itemized deduction reduces the amount of your income subject to tax. You can deduct the costs of qualifying work-related education as business expenses. This is education that meets at least one of the following two tests.
1. The education is required by your employer or the law to keep your present salary, status, or job. The required education must serve a bona fide business purpose of your employer.
2. The education maintains or improves skills needed in your present work. However, even if the education meets one or
both of the above tests, it is not qualifying work-related education if it:
1. Is needed to meet the minimum educational requirements of your present trade or business, or
2. Is part of a program of study that will qualify you for a new trade or business.
You can deduct the costs of qualifying work-related education as a business expense even if the education could lead to a degree. Once you have met the minimum educational requirements for your job, your employer or the law may require you to get more education. This additional education is qualifying work-related education if all three of the following requirements are met.
1. It is required for you to keep your present salary, status, or job,
2. The requirement serves a business purpose of your employer, and
3. The education is not part of a program that will qualify you for a new trade or business.
When you get more education than your employer or the law requires, the additional education can be qualifying work-related education only if it maintains or improves skills required in your present work.
Example. You are a teacher who has satisfied the minimum requirements for teaching. Your employer requires you to take an additional college course each year to keep your teaching job. If the courses will not qualify you for a new trade or business, they are qualifying work-related education even if you eventually receive a master’s degree and an increase in salary because of this extra education.
14A. True – Correct Return
You do not have to keep duplicate copies of your records and documentation you give to your employer if you are an employee who is reimbursed for expenses. However, you should keep your records for a 3-year period if:
1. You claim deductions for expenses that are more than your reimbursement,
2. Your employer does not use adequate accounting procedures to verify expense accounts,
3. You are related to your employer, or
4. Your expenses are reimbursed under a non-accountable plan.
If any of the above cases apply to you, you must be able to prove that your expenses are deductible. You should keep adequate records or have sufficient evidence that will support your expenses. Estimates or approximations do not qualify as proof of an expense. Some examples of what can be used to help prove your expenses are:
1. Documents, such as transcripts, course descriptions, catalogs, etc., showing periods of enrollment in educational institutions, principal subjects studied, and descriptions of educational activity.
2. Canceled checks and receipts to verify amounts you spent for:
a. Tuition and books,
b. Meals and lodging while away from home over night for educational purposes,
c. Travel and transportation, and
d. Other educational expenses.
3. Statements from your employer explaining whether the education was necessary for you to keep your job, salary, or status; how the education helped maintain or improve skills needed in your job; how much reimbursement you received; and the type of certificate and subjects taught, if you are a teacher.
4. Complete information about any scholarship or fellowship grants, including amounts you received during the year.
14B. False – Incorrect Return
You must keep records as proof of any deduction claimed on your tax return. Generally, you should keep your records for 3 years from the date of filing the tax return and claiming the deduction. However, if you are an employee who is reimbursed for expenses and you give your records and documentation to your employer, you do not have to keep duplicate copies of this information unless a following exception applies:
1. You claim deductions for expenses that are more than your reimbursement,
2. Your employer does not use adequate accounting procedures to verify expense accounts,
3. You are related to your employer, or
4. Your expenses are reimbursed under a non-accountable plan.
Copyright © 2007 By
CPE Accounting and Tax Institute
All Rights Reserved