Tax Benefits for Graduate Students
By Karl L. Fava, CPA And Thomas P. Hubbard as appeared in the March 10, 2003 edition of The Chicago Business, (Volume XLI, Number 5)
Prior to the Taxpayer Relief Act, (TRA), of 1997 there was really only one way for a Graduate School Student to obtain any tax benefit for the cost of one’s education and that was to deduct it as a business expense, which even today is still a viable tax strategy. The deduction of one’s graduate education as a business expense is not specifically provided for in the Internal Revenue Code. Even so the promulgation for the deduction can be found in Treasury Regulation 1.162-5 and case law that has developed over the years in support of taxpayers taking this deduction.
Typically, for one to argue that their graduate education is tax deductible the education cannot be a requirement to meet minimum qualifications for one’s employment and the education does not qualify the taxpayer for a new trade or business. Additionally, the education must maintain or improve skills required by the taxpayer in their trade or business or is to meet express requirements for the taxpayer’s employer or requirements of law. Many graduate programs, including Masters in Business Administration, are extensions of what a taxpayer has already been doing within their trade or business, occupation, or profession. Not only does this argument aid business people working on a Masters, it also benefits teachers, architects, social workers, and engineers, (to name a few professions), working on their graduate degrees.
As noted above TRA 97 along with the Economic Growth and Tax Relief Reconciliation Act of 2001 provided for tax benefits attributable to the cost of graduate education. A few of these provisions are as follows:
Lifetime Learning Credit
The Lifetime Learning Credit allows a student to offset their tax liability with a credit of up to a maximum of $1,000, per year. The credit is based on 20% of the first $5,000 of qualified tuition and related expenses paid to an eligible educational institution. Part time students qualify for this credit along with students not working on a specific degree program. There are income limitations on the utilization of this credit, and for the 2002 tax year the phase out ranges for the Credit based on adjusted gross income are:
Joint Taxpayers : $82,000 to $120,000
Single or Head of Household Taxpayers : $41,000 to $51,000
The credit is not allowed if the student is being claimed as a dependent on someone else’s return. Room and board does not qualify as a related expense and a taxpayer may amend a tax return in order to claim or remove the credit.
Deduction for Higher Education Expenses
Beginning in 2002, a taxpayer can claim up to $3,000 of qualified tuition expenses as a deduction even if they do not itemize. Qualified tuition includes tuition, activity fees, books, supplies, and equipment to the extent that the fees are paid to the institution as a condition of enrollment or attendance. Expenses must be reduced by tax-free assistance such as scholarships, grants, employer provided assistance, and any other nontaxable payments. Expenses that don’t qualify are insurance, medical expenses, room and board and other personal living expenses. An eligible institution is any college, university, vocational school, or any other postsecondary educational institution eligible to participate in a student aid program administered by the U. S. Department of Education. This definition includes virtually all accredited, public, nonprofit, and private postsecondary institutions.
As with the Lifetime Learning Credit there is a phase out of this deduction based on one’s adjusted gross income.
For the 2002 and 2003 tax years the maximum $3,000 deduction is limited to taxpayers with incomes below the following thresholds:
Joint phase out (modified adjusted gross income) : $130,000
Single or HOH (modified adjusted gross income) : $65,000
A taxpayer cannot take the deduction for higher education expenses if any of the following apply:
- The taxpayer can be claimed as a dependent on someone else’s return
- The taxpayer’s filing status is married filing separate
- The taxpayer is a nonresident alien.
- The taxpayer is claiming the Hope or Lifetime Learning credits
- The taxpayer is taking their educational expenses as a business deduction on Form 2106
The unique thing about the above two tax strategies is that, if done correctly, can be used in conjunction with the business expense deduction. As noted above, the deduction for higher education expenses cannot be used if the expenses are also used on the Form 2106, (unreimbursed business expense), but this does not preclude a taxpayer from using a portion of the expense in each of the two categories. The key to tax minimization with the educational costs is to optimize the expenses across the various benefits and deductions a taxpayer may be able to use.
Other potential tax benefits relative to graduate students that have rolled out of the 97 and 01 tax acts, to name a few, relate to the deductibility of student loan interest and the ability to avoid taxation on interest from certain U.S. savings bonds cashed in for educational purposes.
As with most aspects of one’s personal tax and financial matters it is always good to consult with a qualified professional before attempting to utilize any of these strategies on one’s personal income tax return.
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 businesses and business people in most major cities. Mr. Fava has been practicing for over twenty years and is a Certified Public Accountant in New York, California, and Michigan. He had spent over ten years with the firms Deloitte & Touche and KPMG Peat Marwick before founding BFC. BFC’s web site is www.bfcinc.com. Mr. Fava’s e:mail address is firstname.lastname@example.org.
Thomas P. Hubbard, BBA, has been a practicing accountant for over eight years with five of them being with Deloitte & Touche. Mr. Hubbard specializes in individual tax matters, foreign national tax planning and multi-state tax planning. His e:mail address is email@example.com.