Tax Smart Ways to Pay for Your Children’s Education

A Summary of the Tax-Smart Ways to Help Pay a Child’s Education Costs - Part II

This is the second of two FEDZONE columns discussing the tax-preferred ways that federal employees can utilize in order to pay for their children’s education expenses. These education expenses range from the cost of nursery school through the cost of graduate school. The first column discussed programs and accounts in which distributions from these accounts are excluded from a parent’s taxable income with respect to federal, and in some cases, state income taxes. This column will present some federal tax deductions (as “adjustments to income” -see below) and federal tax credits when it comes to paying education expenses.

Deductible Contributions to a Traditional IRA and Penalty-Free Distributions

For the year 2023, deductible contributions of up to $6,500 ($7,500 if an individual is over age 49 as of December 31, 2023) can be made to a traditional IRA with a contribution deadline of April 15, 2024. Distributions from the traditional IRA used to pay for college tuition and fees (but not room and board) are taxable but will avoid the 10 percent early (pre age 59.5) withdrawal penalty. For traditional IRA owners who participate in an employer-sponsored retirement plan (such as federal employees), the traditional IRA contribution deduction is “phased out” when the IRA owner’s 2023 modified adjusted gross income (MAGI) is between $73,000 and $83,000. These AGI limits apply to single or head of household tax filers. For individuals who file as married filing jointly, the MAGI limits are $116,000 through $136,000. A traditional IRA owner who has made nondeductible IRA contributions to hir or her traditional IRA over the years can withdraw the IRA contributions, tax-free together with the accrued earnings. The accrued earnings would be taxable when withdrawn but not subject to a 10 percent pre age 59.5 early withdrawal penalty if used to pay for college tuition and fees. For 2024, traditional IRA contributions increase to $7,000 ($8,000 if the IRS owner is over age 49 as of December 31, 2024).

Student Loan Interest Deduction

Individuals can deduct up to $2,500 of interest paid on qualified education loans for college or vocation school expenses as an “adjustment to income”. The tax deduction is available for interest paid on qualifying loans for the benefit of the individual, the individual’s spouse, or the individual’s tax dependent at the time the student loan debt was incurred. For 2023, the deduction is “phased out” when MAGI is between $75,000 and $90,000 for single or head of household tax filers, and between $150,000 and $180,000 of MAGI for married filing jointly filers. MAGI is adjusted gross income before the student loan interest deduction and foreign earned income or housing exclusion deduction.

More Tax Smart tips: Ed hosts a Tax Planning Webinar for Federal Employees -

Qualified education loans are loans taken out solely to pay qualified education expenses including tuition and fees, room and board, books, equipment and transportation for an eligible student to attend an eligible education institution.

The student loan interest deduction is not available to individuals who are claimed as dependents on another individual’s tax return. Those individuals who file as married filing separately are not eligible to take the student loan interest deduction.

American Opportunity Tax Credit (AOTC)

A tax credit of $2,500 per student is available for each of the first four years of post-secondary education. Credit is 100 percent of the first $2,000 of expenses and 25 percent of the second $2,000 of expenses. If the credit exceeds the tax liability, up to 40 percent of the credit may be refundable.

Tuition and related expenses (including books and supplies) of the individual who is claiming the credit, or the tuition and related expenses of the individual’s spouse or the individual’s tax dependent can be used as a basis for the credit. The following expenses cannot be used as a basis for the AOTC: (1) Room and board; (2) Student activity fees; (3) Athletic fees; (4) Insurance expenses; and (4) Transportation expenses.

For 2023, and 2024, the AOTC is phased out for individuals who file as single or head of household with adjusted gross income (AGI) between $80,000 and $90,000; for individuals who file as married filing jointly the AOTC phases out when the AGI is between $160,000 and $180,000. Individuals filing as married filing separately are ineligible to take the AOTC.

Lifetime Learning Credit (LLC)

A tax credit of 20 percent of up to $10,000 of higher education expenses paid by an individual. The LLC cannot be used in the same year the American Opportunity Tax Credit is claimed. Tuition and related expenses of the individual, the individual’s spouse, or the individual’s tax dependent can be used as a basis for the LLC. Books and course materials can be used as a basis for the LLC, but only if they are purchased from the institution as a condition of enrollment or attendance. The following cannot be used as a basis for the LLC: (1) Room and board; (2) Student activity fees; (3) Insurance expenses; (4) Athletic activity fees; and (5) Transportation expenses.

For 2023 and 2024, the LLC is phased out for individual who file as single or head of household when their adjusted gross income (AGI) is between $80,000 and $90,000. For individuals who file as married filing jointly the LLC phases out when their AGI is between $100,000 and $180,000. Individuals filing as married filing separately are ineligible to take the LLC.

Child and Dependent Care Credit (CDCC)

A tax credit of 20 to 35 percent of $3,000 (for one dependent) and $6,000 (two or more dependents) of qualifying care expenses for dependent children under the age of 13 and physically or mentally disabled dependents who live with an individual over half of the year. Qualifying expenses for the CDCC include preschool, before school and after school program expenses, summer day camp expenses and adult day care.

For married couple, the earnings of the lower earning spouse must exceed the $3,000/$6,000 thresholds unless the spouse is disabled or a full-time student.

Employees and retirees who may have problems or questions as to how to use these federal tax deductions and tax credits to help pay and minimize the cost of education for themselves and dependents are advised to contact a knowledgeable tax professional.

Edward A. Zurndorfer is a CERTIFIED FINANCIAL PLANNER™ professional, Chartered Life Underwriter, Chartered Financial Consultant, Chartered Federal Employee Benefits Consultant, Certified Employees Benefits Specialist and IRS Enrolled Agent in Silver Spring, MD. Tax planning, Federal employee benefits, retirement and insurance consulting services offered through EZ Accounting and Financial Services, and EZ Federal Benefits Seminars, located at 833 Bromley Street - Suite A, Silver Spring, MD 20902-3019 and telephone number 301-681-1652. Raymond James is not affiliated with and does not endorse the opinions or services of Edward A. Zurndorfer or EZ Accounting and Financial Services. The information has been obtained from sources considered to be reliable, but we do not guarantee that the foregoing material is accurate or complete. While we are familiar with the tax provisions of the issues presented herein, as Financial Advisors of RJFS, we are not qualified to render advice on tax or legal matters. You should discuss tax or legal matters with the appropriate professional.