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Education IRAs
First and foremost, the 1998 Act provides that any balance remaining in an education IRA is treated as distributed within 30 days after the date that the beneficiary reaches age 30 or dies, whichever occurs first. This means if the earnings in the account are not used or transferred to another qualified individual within 30 days after reaching age 30 or death, the earnings will be subject to tax and a 10% penalty.
In addition, the new law waives the 10% penalty tax for distributions from an education IRA not used to pay qualified higher education expenses if:
1. The beneficiary waives the tax-free treatment of a distribution from an education IRA; and
2. The distribution is made on or before the beneficiary's income tax return due date (including extensions) for the year.
This provision was placed into law because there are certain other education benefits that are NOT available to an individual who receives a tax-free distribution from an education IRA (such as the Hope credit or the Lifetime Learning credit). In a year when you will benefit more from using those credits than from having a tax-free distribution from an education IRA, you may now waive the tax-free treatment of the education IRA distribution without being subject to the 10% penalty tax. Obviously, you should always try to avoid having distributions from an education IRA in the same year that you expect to have other education tax breaks available that can't be used in conjunction with the education IRA.
Finally, the new law makes clear that the education IRA contribution beneficiary must be "a life in being." That is, a living person. So this clarification closes the issue of opening an education IRA for a yet unborn child or grandchild.
Deduction for Student Loan Interest
The 1998 Act makes it clear that the student loan interest deduction may be claimed only for loans incurred solely to pay qualified higher education expenses. This being the case, revolving lines of credit generally would not constitute qualified education loans unless the borrower agreed to use the line of credit to pay only qualifying education expenses.
The 1998 Act also provides that the 60 months during which the deduction is allowed will be determined in the manner prescribed by the IRS in the case of multiple loans that are refinanced by, or serviced as, a single loan.
As noted above, these are only some of the highlights of the 1998 Act. There are many other provisions that impact estate taxes, business taxes, and corporate/partnership taxes. But this is a brief overview of the provisions that may have an impact to the vast majority of you. If you have any questions on any of the provisions noted, be sure to post a question in the Tax Strategies message folder.
-- Roy Lewis
Please note that Roy cannot answer individual questions via e-mail. If you have tax questions, please ask them on the taxes message board. Thanks!
As you'll remember, the 1997 Tax Act allowed an individual to make a non-deductible contribution of up to $500 per year to an education IRA to pay for qualified higher education expenses of a qualified person (such as yourself, a child or spouse). Earnings on the education IRA are not subject to tax until distributed, and even on distribution won't be taxed if used to pay qualified higher education expenses. Distributed earnings that are NOT used to pay higher education expenses are includable in income and are subject to a 10% penalty. But there have been a few changes and clarifications to the education IRA issue.
The 1997 Tax Act provided for certain individuals who have paid interest on qualified education loans after December 31, 1997, to claim an above the line deduction for such interest expenses up to a maximum specified amount ($1,000 of interest paid in 1998).