By William Baldwin, Forbes Staff
Why this country can’t have a flat tax: Higher education would suffer.
This is a set of instructions that will enable you or a loved one to claim a little-known tax benefit that will help pay for a college degree. Read carefully, because tax rules must be followed conscientiously and the sequence gets a little complicated. It involves adjusted qualified education expenses (AQEE), an exclusion phase-out, compound interest and American Samoa.
The tax benefit is called the Education Savings Bond Program. I read about this program in IRS Publication 970.
The idea is that you buy savings bonds when your kid is born and the interest compounds until the bonds mature (20 years). You cash in the bonds and use the money to pay tuition. If you qualify for the tax benefit, the interest income is free of tax.
More precisely, it may be partly free of tax, depending on your income and on how much of the bond proceeds go to tuition and fees.
Example. Suzy Creamcheese cashes in bonds worth $10,400, but has only $8,320 of AQEE. Yes, you could be sending your kid to an expensive private college and still have only $8,320 of qualified expenses, since the qualified expenses are what’s left after subtracting room and board, books, distributions from 529s and scholarships.
Since she’s using only 80% of the bond proceeds for AQEE, Suzy can exclude at most 80% of her interest.
That partial interest amount is then subject to a phase-out. The exclusion phases out if Suzy’s income gets too high.
To do the phase-out on Form 8815, Suzy first needs to calculate modified adjusted gross income.
That’s simple. You take income. Then you adjust it. Then you modify it.
The Internal Revenue Service spells out the modifications in its instruction sheet. Suzy has to add back the deduction for domestic production activities. There’s also something about “interest expense attributable to royalties and deductible on Schedule E, Supplemental Income and Loss.” Then Suzy adds the exclusion of income by “bona fide residents of American Samoa.”
Don’t skip this step. There’s probably an IRS prison farm in Mississippi where people are doing hard time for not adding back the Samoa money.
Suppose the modified adjusted gross income comes to $129,250. If Suzy is filing jointly, she subtracts this from $139,250, then divides the result by $30,000. The resulting fraction, one-third, is then multiplied by the maximum interest exclusion arrived at above. In our example Suzy would be permitted to exclude one-third of 80% of her interest.
How much interest are we talking about? Not much.
For the good of the country, Ben Bernanke is running off $100 bills and using them to cover the deficit. That pushes interest rates down. So the coupon on the savings bonds is 0.2%. Also, the most you can put into Series EE savings bonds in any one year is $10,000.
Twenty years at 0.2% sounds like only 4%, but there’s compounding. If Suzy invests $10,000, she earns $408 between now and 2033.
The benefit here is a tax holiday on a third of 80% of $408, or $109. In her tax bracket, Suzy will save $27.20, and she can use that windfall toward the cost of college.
Flat tax? Politically, it can’t happen. If there were a simple tax code Suzy would be out $27 and universities would be up in arms.
…read more
Source: FULL ARTICLE at Forbes Latest
