Help Your Student Qualify For An Uncle Sam Tax Scholarship

When it comes time for your child or children to attend college, will you be able to afford it? This is a question that is burdening many parents, as college tuition inflation has increased at an alarming average rate of 12% annually from 2010 to 2022, while the cost of tuition even at public 4-year institutions increased 9.24% over this same time period¹.

Strategically, the simplest solution is to begin saving large sums and saving early, but this might not be financially feasible for younger parents with younger children. And certainly a 529 or an UTMA/UGMA² account are favorable places to save, but parents might not be able to accumulate enough in these accounts to cover the increasing costs of college.

One place that parents may turn to for help – the Federal Government. The tax code offers two education credits that may benefit families:  the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC). For the purposes of this article, we’ll focus on the AOTC since it offers the richer benefit of these two Credits.

The American Opportunity Tax Credit is a credit for qualified education expenses paid for an eligible student for the first four years of his/her higher education. Parents can receive a maximum annual credit of $2,500 per eligible student.

The amount of the credit is 100 percent of the first $2,000 of qualified education expenses that parents paid for each eligible student, and 25 percent of the next $2,000 of qualified education expenses parents paid for that student. If the credit reduces the parents’ tax liability to zero, 40 percent of the remaining amount of the credit (up to $1,000) will be refunded to them.

Unfortunately, this credit is not readily available for parents who are high wage earners. For tax year 2023, the IRS has imposed an income threshold such that the Modified Adjusted Gross Income (MAGI) must be $80,000 or less for single filers and $160,000 or less for joint filers to receive the full credit, although a reduced credit may be received for higher income thresholds.

Despite these income limitations, high-earning parents still may have the opportunity to take advantage of the AOTC. If their college student provides more than one-half of his/her annual financial support [IRS Section 152(c)], then the child can file his/her own tax return and become eligible to claim this Credit. As most teenagers don’t have the financial means to support themselves, then how might they may provide more than one-half of their financial support?

The answer, quite simply, is gifting. Parents are permitted to gift to their child an amount equal to $17,000 per parent annually, up to $34,000 jointly in 2023. These gifts can be made in cash, but the strategy works best if the gifted amounts are highly-appreciated investments – for example, stocks with a low-cost basis and high unrealized gains.

These gifts should be made to a custodial investment account such as an UTMA or UGMA in the student’s name. As custodian, the parents retain the control and rights to distribute funds from these accounts for the benefit of their child. When the student reaches age 18 or 21, depending on the state, the student takes control of the account. Since the account is the student’s property, any funds used from the account are considered support provided by the student.

At some point after the gifts have been completed, the investments may be sold to raise funds to provide for the child’s support. After total expenses for the year have been calculated and it is determined that the student has provided for half of his/her own support, then the student should file his/her own tax return and is eligible to claim the standard deduction plus the American Opportunity Tax Credit (AOTC).

This tax-saving tactic can be repeated for all four years of college, resulting in a potential Uncle Sam scholarship up to $10,000… per child!

We encourage you to reach out to us to see if you might become eligible to claim this Credit and potentially save thousands of dollars on your family’s college costs. And in the process, be sure to ask the most strategic way to establish a 529 account to take advantage of additional tax benefits!

 

Sources/Info:

¹ https://educationdata.org/college-tuition-inflation-rate

² Uniform Transfers to Minors Act / Uniform Gift To Minors Act

Pursuant to requirements imposed by the Internal Revenue Service, any tax advice contained in this communication (including any attachments) is not intended to be used, and cannot be used, for purposes of avoiding penalties imposed under the United States Internal Revenue Code or promoting, marketing or recommending to another person any tax-related matter. Please contact us if you wish to have formal written advice on this matter.

This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting advice. You should consult your own tax, legal and accounting advisors before engaging in any transaction.