One of the future goals for your children is their financial security and assistance with educational objectives and goals. It is important to demonstrate the value of saving money and taking advantage of tax breaks. The Tax Cuts and Jobs Act (TCJA) which contains provisions affecting tax planning for children and their education.
Section 529 plans provide valuable tax-advantage savings opportunities for your students. Although the contributions are not tax deductible for federal purposes, any growth is tax-deferred. If used for qualified education expenses the funds are distributed tax free. Under the TCJA, 529 plans can now be used for K-12 tuition and fees up to $10,000 per year.
A special tax advantage for the 529 plans is to allow you to front-load five years’ worth of annual gift tax exclusions and make up to a $75,000 contribution.
Coverdell Education Savings Accounts
Like the 529 plans the contributions are not tax deductible for federal purposes, but plan assets grow tax-deferred and distributions used to pay qualified education expenses are tax free.
Coverdell’s can be used for K-12 expenses for tuition and fees as well as other qualified expenses such as uniforms, transportation, program fees, computers and internet costs.
Unlike the 529 plans, however, the ability to contribute to a Coverdell plan are subject to income limitations. The phase-out for single taxpayers starts at $95,000 and $190,000 for joint returns.
Achieving a Better Life Experience (ABLE) accounts offer a tax-advantaged way to fund qualified disability expenses for beneficiary who became disabled or blind before age 26. Under the TCJA 529 education plan funds can be rolled over to an ABLE account without penalty. The ABLE account must be owned by the beneficiary of the 529 plan or by a member of their family. The rolled-over amounts count toward the overall ABLE account annual contribution limit which is $15,000 for 2018.
The “kiddie tax” generally applies to unearned income of children under the age of 19 or under age 24 for a full-time student. Before 2018, unearned income was generally taxed at the parents’ tax rate
Under the TCJA the kiddie tax will now be taxed according to the tax brackets which are used for estate and trusts. The tax return of your children will no longer be dependent on the parents return or the returns of siblings who are also subject to the kiddie tax.
IRAs for Teens
IRAs can be perfect for teenagers because they likely will have many years to let their accounts grown tax-deferred or tax-free.
Choosing a Roth IRA typically provides a better tax advantage for your teenager. Now that the standard deduction is $12,000 for single taxpayers (even if they are dependents on their parents return) it is most likely that the traditional IRA would not provide a pre-tax benefit. Your child can have income up to $12,000 without a tax filing requirement but they now have income to fund a Roth IRA (which is post-tax) which grows tax-deferred and can be distributed tax-free.
American Opportunity Credit
The maximum credit, per student, is 2,500 per year for the first four years of postsecondary education. Both the AOTC and a distribution from either a 529 plan or Coverdell can be taken in the same year as long as the expenses are not the same.
The AOTC does have income threshold limitations; the phase-out range for single taxpayers is $80,000 to $90,000 and the phase-out range for joint files is $160,000 to $180,000.
Contact our office if you have any questions regarding these tax-deferred or tax free programs to help your student with meeting their higher education goal.
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Keana Spencer is an Accountant, Entrepreneur, and Educator to her clients, with a strong passion. Keana has over 10 years of experience and through her practice, she is a source of knowledge and strategies to her clients.