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By: Julie Welch, CPA/PFS, CFP | Education expenses can reduce taxes in one of three ways. First, job-related education expenses can be deducted, along with other miscellaneous itemized deductions, to the extent they exceed 2% of the adjusted gross income. Education expenses are deductible if they are: job related, do not qualify a person for a new business, and are not taken to meet the minimum educational standards for qualification in a person’s business. The costs of obtaining an undergraduate degree do not qualify because they are usually meeting the minimum educational standards. The costs of obtaining a graduate degree, especially in business, generally qualify if a job is in the same subject area as the classes unless the degree qualifies that person for a new business, such as law or medicine. Examples of some of the costs that can be deducted include tuition, books, supplies, car expenses, and travel costs.
Second, job-related education expenses can be excluded as a working condition fringe benefit. Many employers used this approach when the educational assistance provisions temporarily expired in prior years.
Third, education expenses under an employer’s educational assistance program can be excluded. This is generally the best approach. Check to see if the employer offers an educational assistance plan. If the employer does, up to $5,250 from income can be excluded. Although meals, lodging, and transportation costs cannot be reimbursed, the costs that can be reimbursed tax-free include: tuition, books, supplies and equipment.
An employer can either pay the expenses directly to the school or reimburse the taxpayer after they are paid. Proof of the expenses will need to be provided, such as receipts for tuition and books.
Unlike the deduction for education expenses, the subjects being studied do not have to be business or job related. Thus, a college degree can be completed or non-business courses can be taken. However, subjects considered a sport, game, or hobby are ineligible unless required as part of a degree program or related to an employer’s business. Graduate courses are also included in this exclusion.
Savings include both income tax and Social Security tax. Additionally, many states do not tax educational assistance reimbursements, thus saving even more.
A person has $45,000 in income, is in the 25% tax rate bracket, and has $5,500 of educational expenses. If that person claims the expenses as a deduction, they will save:
Education expenses $5,500
2% floor ($45,000 x 2%) ($900)
Deductible education expenses 4,600
Income tax rate 25%
Tax savings $1,150
If a person’s employer reimburses $5,250 of their educational expenses under an educational assistance plan, the following will be saved:
Federal income tax savings
at 25% tax bracket $1,313
Social Security taxes at 7.65% for 2013 402
Total savings $1,715
The unreimbursed education expenses of $250 ($5,500 - 5,250) are considered a miscellaneous itemized deduction subject to the 2% floor. The person receives no additional tax savings since 2% of the adjusted gross income of $900 ($45,000 x 2%) exceeds the $250.
The person saves $565 ($1,715 - 1,150) in tax by using their employer’s educational assistance plan.
Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 10th edition.
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- Written by: Julie Welch, CPA/PFS, CFP
By: Julie Welch, CPA/PFS, CFP | Health Savings Accounts (HSAs) are similar to individual retirement accounts (IRAs) for medical expenses. Both individuals and employers can contribute to HSAs for eligible individuals.
If you are eligible, you can make deductible contributions to an HSA that is administered by a financial institution or insurance company. The money in the plan, which you may invest in certificates of deposit, stocks, bonds, mutual funds, and similar investments, grows tax-free. Distributions you take to pay for qualified medical expenses are tax-free. If you take a distribution that you do not use to pay for qualified medical expenses, you must pay tax plus a 10% penalty on the distribution amount. The 10% penalty will not apply if you die, become disabled, or reach age 65.
To be eligible for an HSA, you must meet several conditions. First, you must be covered under a high-deductible health insurance plan. For self-only coverage for 2014, the plan must have an annual deductible of at least $1,250 and annual out-of-pocket expenses (deductibles, copayments, and other amounts, but not premiums) not exceeding $6,350. For family coverage for 2014, the plan must have an annual deductible of at least $2,500 and annual out-of-pocket expenses not exceeding $12,700. Except for preventive care, the plan may not pay benefits until you or your family has incurred annual covered medical expenses in excess of the minimum annual deductible.
Second, you may not be covered by any other health plan that is not a high-deductible health plan, including your spouse’s plan, your parent’s plan, or Medicare. However, you may still be covered under workers’ compensation laws, insurance for your auto and home, insurance for a specified disease or illness, insurance that pays a fixed amount per day of hospitalization, and insurance covering accidents, disability, dental care, vision care, or long-term care.
Third, you may not be claimed as a dependent on another person’s tax return.
Qualified medical expenses that you can pay using your HSA are those that would be deductible for tax purposes as medical expenses. These expenses may be for you, your spouse, or your dependents, but they cannot be covered by insurance. You cannot have your HSA pay your health insurance premiums, since they are not qualified medical expenses. However, your HSA can pay for qualified long-term care insurance, COBRA health care continuing coverage, and your spouse’s or dependents’ premiums for Medicare Part A or B coverage.
You may deduct your contribution to your HSA up to $3,300 for 2014 for self-only coverage ($6,550 for 2014 for family coverage). If you are 55 or older, you can contribute $1,000 extra to your HSA.
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You are 40 years old, single, and self-employed. You are covered under a high-deductible health insurance plan. In January, you open an HSA at your local bank by depositing $1,500, the annual deductible for your high-deductible health plan. You direct the bank to invest the $1,500 in a mutual fund, which has $100 of earnings for the year. During the year, you pay $700 for qualified medical expenses. You can deduct the $1,500 you contributed to the account. You do not pay tax on the $100 earned from the mutual fund or the $700 you withdrew to pay for medical expenses. |
Similar to IRAs, you have until April 15th to make an HSA contribution for the previous year. If you make your HSA contribution between January 1st and April 15th of the following year, you must indicate that you want your contribution to apply to the prior year or it will automatically be applied to the current year.
Once during your lifetime, you may fund your HSA with a tax-free rollover from your IRA. The rollover amount is limited to the maximum deductible contribution to your HSA. This may be beneficial if you do not have the cash to put into your HSA. You may also be able to roll over amounts in your Flexible Spending Accounts and Health Reimbursement Accounts into your HSA in certain circumstances.
NOTE: Your employer may contribute to your HSA and can pay the premiums for your high-deductible health plan on a deductible basis. Your employer’s contributions are not taxable to you. This approach provides income tax and employment tax savings to you and your employer.
Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 10th edition.
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You can deduct medical and dental expenses that are over 7.5% of your adjusted gross income (AGI). Medical insurance reimbursements reduce your deductible amount.
You pay $10,000 for medical and dental care for the year. Your AGI is $100,000. You can deduct $2,500 ($10,000 − (100,000 × 7.5%)) as an itemized deduction.
If your medical insurance reimbursed $8,000 of your expenses, you cannot take a deduction. The $2,000 ($10,000 − 8,000) of unreimbursed expenses does not exceed $7,500 ($100,000 × 7.5%).
Because of these limitations, many individuals cannot take a deduction for medical and dental expenses. Increase the likelihood of getting a deduction by identifying all of your qualifying medical expenses.
Payments for the diagnosis, cure, mitigation, treatment, or prevention of disease qualify. These expenses can be for you, your spouse, or relatives you support. Expenses that are beneficial to your general health do not qualify.
Deductible Medical Expenses
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Medical and dental insurance premiums including Medicare Part B premiums and limited amounts for long-term care insurance premiums
- Fees for doctors, dentists, and other medical practitioners
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Fees for hospitals and medical centers providing psychiatric, drug, or alcohol treatment, including meals and lodging
- Fees for physician-prescribed weight-loss programs to treat and existing disease
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Special equipment, such as wheelchairs, crutches, artificial limbs, eyeglasses (including contact lenses), hearing aids, and breast pumps
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Improvements to your home such as elevators, air filtration equipment, and swimming pools to the extent they exceed the increase in value of your home and are needed for medical purposes
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Transportation costs, including auto expenses at either 19¢ (16.5¢ for 2010) per mile or your actual costs
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Cosmetic surgery, if it corrects a deformity arising from a birth abnormality, a personal injury, or a disfiguring disease
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Special schools or homes for people with mental or physical disabilities
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Nursing homes and other costs for long-term care
This list includes some examples of the types of medical expenses that are deductible. If you have made a payment that might qualify, research it. The list of qualifying deductions continues to expand.
Do not forget to include medical and dental insurance premiums that are withheld from your wages. Check your pay records to see if you are sharing your health insurance costs with your employer.
NOTE: If you are self-employed, you may be able to deduct 100% of your health insurance costs in arriving at your adjusted gross income.
NOTE: Employees may be able to take advantage of Health Savings Accounts (HSAs) to pay health care costs. HSAs allow workers with high-deductible health insurance to make pre-tax contributions of up to $3,050 annually ($6,150 for families). If you are 55 or older, you can contribute $1,000 extra to your HSA annually. Employees of small businesses and self-employed people may be able to take advantage of medical savings accounts (Archer MSAs) to pay health care costs. The ability to create new Archer MSAs expired on December 31, 2007, but contributions to existing Archer MSAs may continue.
Do Not Split Medical Care Expenses
For purposes of the medical expense deduction, the definition of a dependent is expanded. The medical expenses of relatives you support, such as parents, grandparents, and children living away from home, are deductible even if you cannot claim the relatives as dependents because they received too much income or were married. Also, for these purposes, dependents include children from a previous marriage even if your former spouse claims them as dependents.
In many cases, children will share the medical care expenses, such as nursing home costs, of a parent. Sharing the expense decreases the likelihood that anyone can get a medical expense deduction. Instead, designate one family member who will benefit from the medical expense deduction as the person who pays. The other family members can give their share to the payer. From year to year, the family members can take turns paying the bills.
For the same reason, do not split the medical care costs of children with your former spouse. Continue to share the costs, but identify which of you is most likely to obtain a medical expense deduction. That parent should actually pay the children’s medical bills for the year. Alternatively, one of you can pay the bills one year and the other pay the next year.
A child who pays taxes can often benefit from a medical expense deduction when a parent cannot. The parent can give the money to the child so the child can make the payment.
In short, have a person who can benefit from the medical expense deduction make the payments.
REVIEW QUESTION
True or False? Fees for meals at hospitals for alcohol treatment are not deductible.
Answer: False
Fees for meals and medical centers providing psychiatric, drug, or alcohol treatment, including meals and lodging are deductible.
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Use the following chart to distinguish among the following education incentives: Qualified State Tuition Plans, American Opportunity Tax Credit/Hope Credit, Lifetime Learning Credit, Coverdell Education Savings Accounts, Interest on Education Loans and Educational Savings Bonds.
Julie Welch (Runtz), CPA, CFP, and Randy Gardner, LLM, CPA, CFP, are the authors of 101 Tax-Saving Ideas, 9th edition, published by Wealth Builders Press. To order ($27.95), call 816-561-1400, fax 816-561-6296 or email
REVIEW QUESTION
Which education incentive for 2010 covers the higher education expenses for tuition, fees, books, supplies, equipment and room and board: Interest on education loans up to $2500, Lifetime Learning Credit, Qualified State Tuition Plans, American Opportunity Tax Credit or Coverdell Education Savings Accounts?
Answer: Interest on education loans up to $2500, Lifetime Learning Credit and Qualified State Tuition Plans
American Opportunity Tax Credit or Coverdell Education Savings Accounts do not cover room and board.
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Follow the chart to determine 2010 capital gains for noncorporate taxpayers.
