College costs have been outstripping inflation for years, a trend that does not seem to be stopping, although there are signs that it might finally be slowing down.
According to the College Board, the average cost of a four-year education ranges from $20,000 a year for an in-state public institution to over $48,000 a year for a private (not-for-profit) college.
Paying for college is a major financial challenge for parents, and certain recent changes to the tax code might affect the tax situation of parents trying to support their children through higher education.
Begin saving at birth
Planning to pay for college is a process that parents will ideally begin when their children are still quite young. There are a number of tax-protected savings options, including 529 plans and Coverdell education savings accounts (Coverdell ESAs).
Parents can establish both types of savings accounts because only Coverdell ESAs have a contribution limit ($2,000 per student per calendar year for a couple with a joint income of under $220,000).
The money in both types of educational savings accounts is not subject to federal or state income tax as it grows. Similarly, funds from these accounts that pay for qualified education expenses (tuition, books, room and board, fees, and similar expenses) are also not taxed.
One recent change to the tax law means that families can use 529 accounts to pay for educational expenses for children attending private school (K through 12), but it’s worth considering whether it would be wiser to leave that money for the higher costs of college.
Don’t depend on dependent status
Be aware that your college student might not automatically qualify as your dependent for tax purposes. In order for you to claim your college student as a dependent, the following criteria must be met:
- The student must be your child, stepchild, foster child, or other descendant.
- The student must live with you for at least half the year (although time spent at college counts as “living with you”).
- The student must be under age 24 on Dec. 31 of the tax year in question.
- The student must be enrolled as a full-time undergraduate at an accredited university.
- The student must not be providing (from income or other taxable sources) more than half of his or her own support during the year.
Pay attention to grandparents’ gifts
If your child has grandparents eager to help pay for college, it actually makes more sense for the grandparents to give you (the parents) the money since each grandparent can give each parent up to $15,000 tax-free (so up to a potential total of $60,000) without that family gift being taxable income — and without the gift affecting your ability to claim your child as a dependent and thus to qualify for certain tax breaks.
Watch that home equity
One final tax change worth noting: While a home equity line of credit has been a popular way for parents to fund their child’s college education, you can no longer deduct the interest on a line of credit used to pay for personal expenses, which reduces the attractiveness of this option.
It might, therefore, be worth examining other potential sources of funding, including student loans, since the interest on these loans is (for now) still deductible.
The bottom line
Paying for college might be a challenge, but college itself is still a worthwhile investment in your child’s future.