It’s back to school time and that may mean thinking about college. Getting into the school of choice is just one hurdle. For many of us, the next leap is into the world of student loans. If this task is on your mind, here are some important considerations:
- Education Loans
- Home Equity Loans
- Tapping Retirement Accounts
Paying for tuition and college expenses may require borrowing money. If you are in this situation, here are some tax implications to consider before taking out a loan.
There are two possible types of loans that can generate a tax deduction for the interest paid: home equity loans and education loans. Each has its own special rules and limitations:
- Education Loan – An education loan can be almost any type of loan as long as it is a single purpose loan; i.e., proceeds are only used for qualified educational purposes. The most commonly thought of education loan is a government-guaranteed student loan, but one could even use a credit card if the card was only used for qualified educational purposes. Probably not a good choice, however, since the interest on credit cards is so high.Interest in this category is an above-the-line deduction—meaning you don’t have to itemize your deductions to claim this benefit, provided the student was enrolled at least half-time in a program leading to a degree, certificate, or other recognized educational credential. However, the maximum interest deduction per year is $2,500, and the deduction phases out for higher income married taxpayers with an AGI between $130,000 and $160,000. For singles, the phase-out range is between $65,000 and $80,000. (These are the 2014 ranges; call for the values for other years.)While loans from relatives or a qualified employer plan are also potential borrowing sources, the interest paid on these loans will not qualify as deductible education interest.
- Home Equity Loan – If you itemize your deductions and have sufficient equity in your home, you might consider borrowing the needed cash from your home. Generally, homeowners can take $100,000 of equity debt on their home and still deduct the interest paid on the loan against the regular tax. Unfortunately, the interest on equity debt is not deductible against the Alternative Minimum Tax (AMT), so consider other alternatives first if you are subject to the AMT. However, even if you are subject to the AMT, your best option may still be taking equity from your home. You may lose the benefit of the interest deduction, but the low interest rate on home loans is still in your favor.
Generally, the borrowed funds must be used for qualified expenses within a reasonable period of time, usually 90 days before or after borrowing the funds. A home equity line of credit can be used to meet these requirements by paying education expenses as they become due, provided the loan is not also used for another purpose.
If you are considering tapping a retirement account to pay for education expenses, explore all other options first. Retirement account distributions are generally taxable and subject to early withdrawal penalties if you are under retirement age, generally 59 1/2.
Please call this office to discuss your education loan options, especially if you are considering tapping a retirement account.