R E L A T E D A R T I C L E How to spot the tax credits you deserve |
New tax credits put money in your pocket Families can get a break by tapping into education and child credits concocted by Congress. By Jeff Schnepper Give Congress a little credit. It took a year for the 1997 tax-law changes to really kick in, but now millions of families in America have the chance to significantly lower their tax bills because of a host of new tax credits. A credit puts money directly in your pockets. It’s a dollar-for-dollar reduction in your tax. In the 28% bracket, a $100 deduction reduces your tax by $28; a $100 credit reduces your tax by $100. The 1997 Taxpayer Relief Act provides several new tax credits that didn't take effect until 1998. Let's take a look at the most significant credits and how we can best take advantage of them: Education credits Congress and the Clinton administration both put special emphasis on education. In an attempt to expand the opportunity for more people to go to college, they created several amendments to our tax code that provide indirect funding for post-secondary educational expenses. Rather than providing direct funding or scholarships based on merit, they have created special credits, deductions and exclusions that reduce your taxes and replace dollars you have spent in approved educational expenses. The first of these is the HOPE (Helping Outstanding Pupils Educationally) scholarship. It offers a tax credit of up to $1,500 a year for the first two years of college. It's a dollar-for-dollar credit on the first $1,000 spent on tuition and then pays 50 cents on the dollar for the next $1,000. To qualify for the HOPE scholarship, the student must be carrying at least one-half the full-time workload and never have been convicted of a felony drug offense. Payments made after Dec. 31, 1997, qualify for the HOPE scholarship The second credit is the Lifetime Learning Credit. It offers a 20% credit on the first $5,000 spent on tuition for undergraduate or graduate expenses. The effective date for this credit is July 1, 1998. It's aimed at the last two years of college, for graduate education or for educational expenses to acquire or improve job skills. Remember that the HOPE scholarship is offered for the first two taxable years of post-secondary education, and for those who are eligible, the HOPE provides a bigger kickback than the LLC. Note that the Lifetime Learning Credit is not just for your kids -- it’s for your own education or to acquire or improve your skills. Both credits have income eligibility ceilings, with income phase-outs starting for families with annual household incomes of $80,000 and complete phase-out at $110,000. For individuals, the phase-out occurs for those people with incomes between $50,000 and $75,000. So what do you do if you make too much money? Just because both you and your spouse slave to make $55,000 each doesn’t mean that you are rich or have vast stores of wealth to fund your kids' expenses. It does mean, however, that you don’t qualify for the HOPE credit. But let’s get a little creative. I currently have three kids in college. The joint income my wife and I enjoy is too high for us to claim the credits -- but all is not lost. Remember that a credit is a dollar-for-dollar reduction in your tax. It doesn’t matter what bracket you’re in; a $1,500 credit saves exactly the same dollars to someone in the 15% bracket as it does to someone in the 39.6% bracket. What I did was make my three kids legally independent. All of my children have income -- whether from investments, working for me (see Tax-savvy ways to fund college education) or both. By using their dollars to pay for their own tuition, each of my kids qualifies for a $1,500 credit! Had they remained my dependents, none of them would have qualified for a credit. By making them independent and claiming the credits on their own returns, my family unit has saved $4,500 in taxes. Moreover, making them independent allows them not only to qualify for additional educational financial aid, but in the case of my children studying out of state, it allows them to qualify as residents in those states and receive lower “in-state” tuition. Child credits That works great with older children. But what can you do to help finance future college expenses if your kids are younger? Well, not only could you fund the new Education IRA, which allows you to put up to $500 a year into a tax-deferred Individual Retirement Account, but you probably can do it with the money you save courtesy of the new child dependency credit. This is a great double-barreled tax saver for families with children. Effective Jan. 1, 1999, the child dependency credit (sometimes known as the kiddie tax credit, but that gets confusing because there's already a pre-existing credit for low-income families with children) is available for families earning $18,500 or more with children under age 17. The credit is $500 per child. It's phased out at a rate of $50 per every additional $1,000 or part thereof earned in excess of $110,000 on joint returns, and in excess of $75,000 for singles. If you have three or more children, you may be eligible for an additional credit. If you qualify, grab it! Then, turn around and use that money in an Education IRA, which phases out for families with joint incomes between $150,000 and $160,000 annually and between $95,000 and $110,000 for single filers. If you're in the 28% tax bracket, you could save nearly $8,000 over a 10-year period in a tax-deductible IRA. That's about $1,000 more than you could have saved in a taxable account. Meanwhile, the money you're using to fund the IRA is coming from the new tax credit. So let's give Congress a little credit for the savings they're offering us beginning in this tax year.
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