By Karl L. Fava, CPA
And Thomas P. Hubbard
as appeared in the March 10, 2003 edition of The Chicago Business, (Volume XLI, Number 5)
Prior to the Taxpayer Relief Act, (TRA), of 1997 there was really only one way for a Graduate School Student to obtain any tax benefit for the cost of one’s education and that was to deduct it as a business expense, which even today is still a viable tax strategy. The deduction of one’s graduate education as a business expense is not specifically provided for in the Internal Revenue Code. Even so the promulgation for the deduction can be found in Treasury Regulation 1.162-5 and case law that has developed over the years in support of taxpayers taking this deduction.
Typically, for one to argue that their graduate education is tax deductible the education cannot be a requirement to meet minimum qualifications for one’s employment and the education does not qualify the taxpayer for a new trade or business. Additionally, the education must maintain or improve skills required by the taxpayer in their trade or business or is to meet express requirements for the taxpayer’s employer or requirements of law. Many graduate programs, including Masters in Business Administration, are extensions of what a taxpayer has already been doing within their trade or business, occupation, or profession. Not only does this argument aid business people working on a Masters, it also benefits teachers, architects, social workers, and engineers, (to name a few professions), working on their graduate degrees.
As noted above TRA 97 along with the Economic Growth and Tax Relief Reconciliation Act of 2001 provided for tax benefits attributable to the cost of graduate education. A few of these provisions are as follows:
Lifetime Learning Credit
The Lifetime Learning Credit allows a student to offset their tax liability with a credit of up to a maximum of $1,000, per year. The credit is based on 20% of the first $5,000 of qualified tuition and related expenses paid to an eligible educational institution. Part time students qualify for this credit along with students not working on a specific degree program. There are income limitations on the utilization of this credit, and for the 2002 tax year the phase out ranges for the Credit based on adjusted gross income are:
Joint Taxpayers : $82,000 to $120,000
Single or Head of Household Taxpayers : $41,000 to $51,000
The credit is not allowed if the student is being claimed as a dependent on someone else’s return. Room and board does not qualify as a related expense and a taxpayer may amend a tax return in order to claim or remove the credit.
Deduction for Higher Education Expenses
Beginning in 2002, a taxpayer can claim up to $3,000 of qualified tuition expenses as a deduction even if they do not itemize. Qualified tuition includes tuition, activity fees, books, supplies, and equipment to the extent that the fees are paid to the institution as a condition of enrollment or attendance. Expenses must be reduced by tax-free assistance such as scholarships, grants, employer provided assistance, and any other nontaxable payments. Expenses that don’t qualify are insurance, medical expenses, room and board and other personal living expenses. An eligible institution is any college, university, vocational school, or any other postsecondary educational institution eligible to participate in a student aid program administered by the U. S. Department of Education. This definition includes virtually all accredited, public, nonprofit, and private postsecondary institutions.
As with the Lifetime Learning Credit there is a phase out of this deduction based on one’s adjusted gross income.
For the 2002 and 2003 tax years the maximum $3,000 deduction is limited to taxpayers with incomes below the following thresholds:
Joint phase out (modified adjusted gross income) : $130,000
Single or HOH (modified adjusted gross income) : $65,000
A taxpayer cannot take the deduction for higher education expenses if any of the following apply:
- The taxpayer can be claimed as a dependent on someone else’s return
- The taxpayer’s filing status is married filing separate
- The taxpayer is a nonresident alien.
- The taxpayer is claiming the Hope or Lifetime Learning credits
- The taxpayer is taking their educational expenses as a business deduction on Form 2106
The unique thing about the above two tax strategies is that, if done correctly, can be used in conjunction with the business expense deduction. As noted above, the deduction for higher education expenses cannot be used if the expenses are also used on the Form 2106, (unreimbursed business expense), but this does not preclude a taxpayer from using a portion of the expense in each of the two categories. The key to tax minimization with the educational costs is to optimize the expenses across the various benefits and deductions a taxpayer may be able to use.
Other potential tax benefits relative to graduate students that have rolled out of the 97 and 01 tax acts, to name a few, relate to the deductibility of student loan interest and the ability to avoid taxation on interest from certain U.S. savings bonds cashed in for educational purposes.
As with most aspects of one’s personal tax and financial matters it is always good to consult with a qualified professional before attempting to utilize any of these strategies on one’s personal income tax return.
Karl L. Fava, CPA, MBA is president of Business Financial Consultants, Inc., (BFC), located in Dearborn, Michigan. His firm handles tax and financial matters for businesses and business people in most major cities. Mr. Fava has been practicing for over twenty years and is a Certified Public Accountant in New York, California, and Michigan. He had spent over ten years with the firms Deloitte & Touche and KPMG Peat Marwick before founding BFC. BFC’s web site is www.bfcinc.com. Mr. Fava’s e:mail address is email@example.com.
Thomas P. Hubbard, BBA, has been a practicing accountant for over eight years with five of them being with Deloitte & Touche. Mr. Hubbard specializes in individual tax matters, foreign national tax planning and multi-state tax planning. His e:mail address is firstname.lastname@example.org.
Year End Tax Planning
By Karl L. Fava, CPA
as appeared in
the November, 2002 edition of Staff Forum, (UAW International Staff Council), Volume 11, Issue 2
Even though there is only a month left in 2002 this is still a good time to implement tax savings strategies. Tax savings and financial planning should be focused on all year long and depending on what time of year it is there are opportunities that everyone should review for applicability. Two of the most important strategies at year-end relate to deferring income and accelerating deductions.
For many taxpayers deferring income may not be an option as they are paid as employees and do not control the timing of their compensation. Business owners or people with sideline businesses typically find it easier to defer income than employees do. Even so, an employee may find some deferral opportunities. An example is year-end bonuses or holiday bonuses and gifts. When you know that there is an imminent payment to be made you should request of your employer to hold off on the payment until the first week of January. In doing so the income will not be taxed until 2003 versus the current year. Additionally, by deferring income you may have the ability to avoid falling into a higher income tax bracket.
An easier strategy to implement is the acceleration of deductions into the current year. One of the most common tactics in this arena is the prepayment of real estate taxes at the end of December versus waiting for the typical winter due dates in January and February. By accelerating a deduction into the current year versus waiting till the next year allows you to reduce income tax now. In doing so you have the benefit of using dollars that would have otherwise been used to fund taxes. Let’s say you are in the 30% tax bracket and you can accelerate $5,000 of additional deductions into the current year. This would create a tax savings of $1,500. This $1,500 could be invested, (even in a simple savings account), and create investment income that you would not have otherwise. Additional areas of deduction acceleration relate to state income taxes. Its always good to calculate before year-end what you project as your Federal and State income tax liabilities. If after doing so your see that you will have a payment due with your State tax return you should fund this liability before year-end versus waiting to make the payment with the actual filing. As with the property taxes the deduction is “pulled forward” and creates an immediate savings for you.
Charitable contributions are also an area for year-end planning. Again, given that contributions are tax deductions you may want to accelerate deductions into the current year. For example you may allocate a certain amount per month for your religious organization. If this is the case you may want to fund the January contributions in December, or even more. In fact, a strategy for individuals who contribute substantial amounts to charities, (tithe), and would not normally have the benefit of itemized deductions is to pay the full of next year’s contributions in December thereby creating two full years worth of deductions in the current year. This may allow a taxpayer to itemize deductions where as they normally would not be able to. In doing so, the taxpayer would set a pattern of itemizing deductions in one year and not in the next.
Year-end security transactions should be reviewed for potential tax savings. If you have incurred capital gains earlier in the year there may be an opportunity to offset that gain with a loss. If you have securities that decreased in value and you do not anticipate the value coming back in the near term it may be a good time to sell for a loss thereby creating a capital loss to offset the gain. (Note there are wash sale rules that would temporarily disallow the loss if the same or similar security were purchased within thirty days). Securities such as stocks can be used as year-end charitable contributions. There is a double benefit here. Lets say you purchased a stock for ten dollars and its now twenty five. If you were to sell it you would incur a fifteen-dollar gain and have to pay taxes on it. Under the rules for contributions of securities you could make a contribution of the $25 stock, not pay tax on the $15 gain, and take a tax deduction of $25.
Other year-end strategies revolve around your financial well being. Before year-end is a good time to consolidate investment and bank accounts. You may have two brokerage accounts and then end up having to track two separate monthly statements. Consolidating the accounts would save you time and file space. You should review this with all of your accounts. Additionally, year-end is a good time to review the financial goals that you established at the beginning of the year to see if you achieved your goals. In doing so, you can begin to summarize your goals for the New Year.
These are just a few of the ideas to implement at year-end. As with all tax and financial related matters it is always good to review your plans and strategies with a professional in that field. The ideas and strategies promulgated may be good for some, but not others. Additionally, there is always the alternative minimum tax that has to be reviewed prior to any income deferral or deduction acceleration.
Karl L. Fava, CPA, MBA is president of Business Financial Consultants, Inc., (BFC). BFC located in Dearborn, Michigan is a nationwide firm providing tax and financial services to individuals and businesses across the country and offshore. In the United States BFC has clients in most major cities and aggressively seeks to maximize tax and financial strategies for them. BFC’s web site is www.bfcinc.com. Mr. Fava’s e:mail address is email@example.com. BFC’s telephone number is (313) 359-9358.