College Planning Newsletter -

How to Use a 529 Plan & Tax Credit for College Expenses

What expenses can you pay for with money from a 529 college-savings account? You can use funds from a 529 account tax-free for tuition, fees, books, supplies and required equipment. But there are also some lesser-known expenses that you can use the money for, which may help you with college expenses for this school year and the next.

The economic-stimulus plan temporarily expanded the rules to allow tax-free 529 withdrawals for a computer and Internet access in 2009 and 2010 (in the past, those expenses qualified only if the school required them). Also, you can also use the money tax-free for room and board, as long as your child or you are at least a half-time student. The full cost of room and board counts if the housing is owned or operated by the college. Off-campus housing costs can qualify, too, up to the allowance for room and board that the college includes in its cost of attendance for federal financial-aid purposes (your college financial-aid office can give you this figure).

While you're deciding how much money to withdraw from the 529 for college costs this year, keep in mind that the stimulus plan also expands the rules governing tax credits for college costs. The new American Opportunity Tax Credit replaces the Hope credit for 2009 and 2010 and increases the amount qualified education expenses for which you can get credit from $1,800 to $2,500. The credit reduces your tax bill dollar for dollar.

You can claim the American Opportunity Tax Credit in the first four years of college (not just the first two years, as was the case with the Hope credit). Also, the income limits to qualify have increased - from $58,000 to $90,000 if you're single and from $116,000 to $180,000 if you're married filing jointly.

However, you can't double dip on tax benefits. For example, the money you use to pay for college expenses from a 529 or a Coverdell education savings account (both of which can already be used tax-free for college bills) cannot not be used with the The American Opportunity Tax Credit for the same college expense amount. The tax credit is based on 100% of eligible college costs up to $2,000, plus 25% of college costs of more than $2,000, which means that you'll need to pay for the first $4,000 in college costs for the year from a source other than a 529 or a Coverdell to qualify for the full credit.

Tuition and fees count toward the American Opportunity credit. Also, course materials such a textbooks are now eligible expenses for the American Opportunity credit as well. However, room and board do not qualify for the tax credit (which was also the case for the Hope and Lifetime Learning credits).

Sharif J. Small, '05

S.J.S. Financial Firm