Changes to the tax code and how they impact paying for college
If you follow the news (and who doesn’t today?!), you know the tax code has undergone a major revision. As the House and the Senate worked through the details of the final bill, lots of back and forth on specifics flew fast and furious. (We’ve written this blog three times trying to keep up!) Finally, the Tax Cut and Job Act has been signed by the President. We have new tax regulations for 2018. How will these new tax rules affect paying for college? Let’s cover some of the specifics.
The new plan removes many of the deductions available to Americans in the past. In return, they doubled the standard deduction your clients can claim if they don’t itemize.
Saving in a 529 plan for private school as well as college?
By far the most popular way to save money for college is in a 529 plan, and for good reason. Your client’s earnings grow tax-free, and as long as the funds are used for higher education their distributions are tax-free. Many states also offer deductions for a portion of the contributions. This will not change.
Now, taxpayers can use 529 plans to pay for K-12 tuition at private and religious schools up to $10,000 per child. In previous years the Coverdell Education Savings Accounts already allowed for this with the same tax benefits as the 529, but these plans aren’t open to high-income Americans and have relatively low contribution limits. The proposed change would expand the use of 529 plans and the number of taxpayers who may use them. Essentially, this would benefit affluent clients saving to pay for private K-12 education.
Your clients need to be careful not to use up 529 funds too soon. Be sure they are saving adequately for the big expense down the road—college!
Paying off student loans?
Currently, some tax filers (based on your clients modified adjusted gross income) can lower their taxable income by up to $2,500 for student loan interest paid during the year. It can be claimed without itemizing.
The removal of the deduction for student loan interest was up for consideration; however, the deduction remains.
Student loan borrower who becomes disabled or dies?
In the past, if someone who has student loan debt becomes permanently disabled or dies, their federal student loan is discharged. However, the amount discharged is considered taxable income on their tax return. This situation remains, but only for a “short” time. In 2025, the discharge amount will no longer be taxable.
Paying for a child’s college now?
Some families (again based on your client’s modified adjusted gross income) claim the American Opportunity Tax Credit (AOTC) for up to $2,500 per child enrolled in college annually. (You can read more in depth about this credit in our blog.)
Another tax credit used by some families is the Lifetime Learning Credit (also covered in our blog). This $2,000 credit, or 20% of the first $10,000 spent in a year, is used by families whose students are attending college less than full time or who already have four years of college credits earned. Keep in mind that this is a $2,000 maximum per household, as opposed to the AOTC that is per child and not available after four years of college.
The House and the Senate disagreed on whether to keep these tax credits. Luckily, the tax credits remain in the final bill. Removing these credits would have more severely impacted lower income families. The AOTC and the Lifetime Learning Credit are not available to families whose incomes are over a certain amount.
Besides the tax credits available, the new tax code obviously will change the amount of income tax a family pays, and in turn a family’s Expected Family Contribution or EFC will also be revised. The EFC determines your client’s need when calculating the college’s aid amount. Lowering your client’s taxes would increase their income and therefore decrease the amount of need-based aid they may qualify for.
For most of your clients, financial aid will be minimally affected; however, it is worth noting. When in doubt, you will almost always want to make the most of any tax benefits for your clients as they are predictable. With financial aid, just because your client qualifies does not mean that the school has the money to give them.
If your client is thinking of using a home equity loan to cover a small gap in their college funding needs? (Read more about this option in our blog.) You should know that under the tax code home equity loan interest is no longer deductible.
Graduate student or college employee?
Many colleges reward their full-time employees with free tuition for themselves, their spouses, and their children. In addition, graduate students who work for those colleges doing research or teaching receive the qualified tuition reduction waiver as well. They are not required to pay taxes on the “free” tuition. This “free” tuition was not taxed in the past. Again, the House and Senate did not originally agree on whether to make this tuition taxable. Thankfully, the tuition remains tax free.
Why would it matter? Employees and graduate students using the qualified tuition reduction are not high income. More than half earn less than $50,000 per year. Another 27% earn between $50,000 and $75,000 per year. (The median US household income is $52,000.) If a graduate student were no longer able to waive the tuition, they will suddenly be expected to pay taxes on $50,000 when in fact they are only earning half that amount.
Receiving tuition assistance from a private employer?
Does your client’s employer help pay for their tuition? Employees are allowed up to $5,250 per year from their employers to cover tuition without having to pay tax on it. This was an item on the potential chopping block, however company tuition reimbursement remains tax free up to $5,250.
(ATTENTION Planners who have small business owners as clients, tuition assistance to their employees is not just for big corporations. We wrote a blog about various tax strategies for small business owners including hiring their children as employees and offering a tuition reimbursement plan. The higher your client’s income tax bracket, the more impactful these tax savings strategies become!)
How are colleges impacted?
Students, employees, and grads are not the only ones impacted by the new tax code. Several provisions could have a large impact on colleges and their financial situation. Why should we care? Because when colleges “suffer” financially, those costs can be passed on to future students in their increased tuition!
What is an endowment? College endowments are very complex made up of many different funds. Charitable donations are the primary funding source for these endowments. Endowments are invested and a small portion around 4-5% of the proceeds is put each year towards operations including student financial aid, teaching, research, athletics, etc. Many charitable donations have restrictions on how the money can be used and for what purpose.
From the National Center for Education Statistics: “At the end of fiscal year 2014, the market value of the endowment funds of colleges and universities was $535 billion…the 120 colleges with the largest endowments accounted for $399 billion, or about three-fourths of the national total.” The endowment at Harvard was $36 billion at the end of 2014.
The new tax code places a 1.4% excise tax on private college endowments valued at $500,000 per full-time student at colleges with over at least 500 students.
Some say this tax is an attack on higher education while others see these large endowments as reflective of our wealth imbalance. The 35 schools who are impacted feel this tax is highly discriminatory. The results of the tax could include decreases in the scholarship money available for those most in need of it as well as higher tuition for everyone.
Effect of property tax deduction limitation or removal
In the past, property owners could claim their state and local property taxes, referred to as SALT, as a deduction on their taxes. This deduction allowed states to charge more in property taxes and use that money to help fund schools (including public K-12 schools, community colleges and public universities).
Now with the deduction limited to $10,000, state and local taxes may suffer and funding to schools could be lost. High tax states like New York and California will be impacted the most.
Charitable giving to colleges and universities
The revised tax code increases the standard deduction for tax filers, meaning less of your client’s income will be subject to federal tax. However, itemizing becomes more difficult. Your client can only itemize if their deductions exceed the standard deduction amount–$24,000 for joint filers/$12,000 for individuals.
Charities benefited in the past because everyday Americans could make donations in any amount and see a tax benefit. Charitable giving was incentivized with a tax reward. Colleges are included in these charities.
Making the standard deduction so high prevents people from itemizing and takes away that tax incentive to give. The fear in the not-for-profit community is that donations from everyday folks will go down significantly if there is no personal tax benefit for doing so.
In addition, the estate tax exemption has been doubled. In the past, the estate tax only applied to estates valued at more than $5.49 million for individuals and $10.98 million for married couples. Now, estates valued at more than $11.2 million for individuals or $22.4 million for married couples are the ones who are taxed. Some large charitable donations including those to universities occurred in the past to bring estates below those old levels. With fewer estates being taxed, the wealthy will not have the tax incentive as a motivation to make large donations.
Hey…are your client’s college sports fans? Something that may impact them…seat licenses. Colleges make large amounts of money from athletic seat licenses. Previously, people who purchased athletic seat licenses can deduct up to 80% of the cost as a charitable donation. This deduction has been removed so the net cost to purchase these tickets goes up significantly.
For example, in the past if your client purchased season tickets for $1,000 they could deduct $800 on their tax return. So, if they were in a 35% income tax bracket they would save $280 in federal tax. That incentive is now gone. Although those who purchase season tickets like these may continue to do so, colleges worry the removal of this charitable benefit will have an impact.
The net result of all this change?
The real major impact of the new tax bill is how it impacts whether or not your client’s itemize going forward. Your clients will only itemize if their deductions are more than the newly increased standard deduction, and for most families it will not.
Dramatic changes to the Higher Education Act are currently under discussion. These changes could have an even larger impact on student loan repayment and college funding. We’ll keep an eye on those discussions and loop you in as they progress.
Change is inevitable, and there is no doubt that these changes will have a profound effect on how our client’s plan and pay for the cost of college education. What has not changed is the need to develop a comprehensive college funding plan that includes:
- a smart saving strategy,
- maximizing financial aid eligibility,
- evaluation and selection of the proper loans,
- optimal asset, income, and tax strategies.
Leave no stones unturned and ensure you are doing everything you can to cut the cost of college for your clients, and they don’t pay a penny more than they absolutely must.