by Karl L. Fava, CPA
as appeared in
the Monday, February 2, 1998 edition of The Wharton Journal, (Volume 42, Number 3)
and as appeared in
the February, 1998 edition of The Kellogg Merger, (Northwestern University)
This past year Congress and President Clinton presented us with the Taxpayer Relief Act of 1997. There has been at least one major tax act voted in by lawmakers every year since 1986. Even so, the current act brings a volume of complex rules and laws not seen since the Tax Reform Act signed by President Reagan in 1986. Ironically, the Act with its expected oxymoronic title: “Taxpayer Relief”, actually does provide taxpayers with quite a few benefits, especially for STUDENTS.
The first provision that was part of the Higher Education Incentives of the Taxpayer Relief Act of 1997, was the Hope Scholarship Credit. Beginning January 1, 1998, taxpayers may be eligible to claim a nonrefundable Hope Scholarship Credit against their federal income taxes. An individual may claim the credit for his/her qualified tuition and related educational expenses. The Hope Scholarship Credit can only be used by a student or a student’s parents when the student is enrolled at least half-time in one of the first two years of postsecondary education and who is enrolled in a program leading to a degree, certificate or other credential. The maximum credit that may be claimed is $1,500, providing that all requirements are met.
Of greater interest to Graduate Students, like MBAs, is the Lifetime Learning Credit. Beginning on July 1, 1998, taxpayers may be eligible to claim a nonrefundable Lifetime Learning Credit against their federal income taxes. The maximum credit a taxpayer may claim for a taxable year is $1,000 through 2002, and thereafter $2,000. Unlike the Hope Scholarship Credit students are not required to be enrolled at least half-time in one of the first two years of postsecondary education. Therefore, Graduate Students can use this credit. Someone participating in any type of continuing education can also utilize the credit as long as the coursework is at an eligible educational institution. As with the Hope Scholarship this credit can be used by the student or the student’s family and there are income limitations on its availability.
As many Graduate Students know there is the opportunity to deduct their educational costs as business expenses if they meet certain requirements. The classic example of this is the deductibility of Graduate Business School expenses. There is a question as to how the tax deduction would work in union with the Lifetime Learning Credit. In writing this article we contacted the author of Internal Revenue Service Notice 97-60 which clarified the higher education incentives in the new tax Act. Unfortunately, the author refused to comment on the cross utilization of these two tax savings mechanisms. It would be expected like any other credit that the expenses used to obtain the credit could not also be deducted. Therefore, someone with $20,000 in Graduate Business School expenses could use the first $5,000 to obtain a $1,000 Lifetime Learning Credit, ($5,000 X 20%), and deduct the remaining $15,000 as a business expense.
The new Act provides a new exception to the ten- percent additional tax (also known as a penalty), on early withdrawals from an IRA when the withdrawal is used to pay qualified higher education expenses. Qualified higher education expenses include tuition, fees, books, supplies, room and board, and equipment expenses. The Act does not provide a penalty exception for early withdrawals from 401(k) plans for use in higher education. As a planning strategy an MBA may want to roll their 401(k) plan into an IRA and then make any necessary withdrawals for educational purposes.
The Act provides an above-the-line deduction for interest paid on qualified education loans. The deduction will be allowed for interest paid during the first sixty months in which interest payments are required and will not be allowed if the taxpayer can be claimed as a dependent on another taxpayer’s return. The limit on the deduction is $1,000 in 1998, $1,500 in 1999, $2,000 in 2000, and $2,500 in 2001 and thereafter.
As with the Hope Scholarship Credit and the Lifetime Learning Credit there are income limitations that preclude taxpayers of these benefits if their incomes are in excess of certain thresholds. The interest deduction provision is effective for payments of interest due after December 31, 1997. If such a loan already exists, interest payments would qualify provided the sixty-month period has not expired.
In addition to the above, the Act also provides for a new IRA that can be used exclusively as a savings mechanism for future educational costs. Also, in some instances the cancellation of certain student loans would not have to be included in gross income of the taxpayer, and pre-paid tuition plans will be treated as a tax-free investment. An employer benefit in the area of education is the extension through 2000 of the exclusion for employer-provided educational assistance.
As with any tax matter the application of the above new laws should be done after consulting with your tax adviser. It is always advisable to consult with a tax professional in matters such as this, and in actuality for all tax planning and compliance matters.
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 individuals located on five continents. In the United States, BFC has clients in most major cities. Along with assisting business people world wide in maximizing tax and financial strategies BFC has been assisting clients in deducting MBA expenses for over eight years. BFC’s web site is www.bfcinc.com. Mr. Fava’s e:mail address is firstname.lastname@example.org.