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Columns by June Walker: IPs Face Unique Tax Challenges Tax Deductions Are There For The Taking You Say You're Self-Employed -- Will the IRS? Criteria for Self-Employment Do You Have a Business or a Hobby? Proving That You're a Business Keeping Records -- It's Not Just for Taxes Three Ways to Expand Your Business Deductions Can I Deduct Disneyland and Other Questions Mixing Business with Pleasure and Other Gray Areas Quicken for IPs Courses That Qualify Training You Can't Deduct Getting There is Half the Battle Taking Deductions on the Road Getting Credit and Taking Allowances Advertising: Do It, Then Deduct It The Subtle Art of Advertising Deductions Billy Bridesnapper's Start-up Saga Starting Up and Shutting Down Start-Up Wrap-Up Giving Gifts, Taking Deductions

Getting Credit and Taking Allowances There's a movement afoot to smarten up America -- to train, to educate, to teach old dogs new tricks -- and IPs are included. Changes in the tax code for 1998 give tax benefits for higher education or vocational school expenses to those who qualify: for the most part, lower- and middle-income Americans. Because you may not claim more than one type of tax benefit from the same expense, if you deduct your education expenses on your Schedule C (Profit or Loss From Business), you are not allowed to then use the same expenses for another tax benefit. You'll have to make some choices, perhaps with the help of your tax advisor. Be sure to read my other columns on education before you make your choice. To make a choice you first need to understand the difference between a tax deduction and a tax credit. A deduction is subtracted from your income -- your tax is calculated on the amount of your income. A $1,000 deduction could save you from zero up to $500 in taxes. A tax credit -- which is usually a greater benefit than a deduction -- is subtracted directly from your tax. A $300 tax credit reduces your tax by $300; a $1,000 tax credit saves you $1,000 in taxes. As an IP, when you deduct business education expenses from your income on your Schedule C, you can save income tax, Social Security, and Medicare tax. That is, if you earn a high enough level of income (and assuming that you haven't already paid the maximum in Social Security taxes for the year). If you use all or part of your qualifying educational expenses toward the tax benefits listed below, you must reduce the amount of the educational expenses that you deduct on your Schedule C by the amount used for those tax benefits. TAX CREDITS Hope Scholarship This provides a tax credit of up to $1,500 per student for the cost of tuition and fees for the first two years of post-secondary education (100% of the first $1,000 of allowed expenses, plus 50% of the next $1,000 of allowed expenses). The term "post-secondary education" includes higher education and vocational schools as well as any other post-high school institution that is eligible to participate in student aid programs administered by the Department of Education. So if you want to tap dance your way to stardom, and want to help finance your lessons by means of these benefits, you'll have to take instructions at the community college rather than with your neighbor, even if he is Gregory Hines. The credit can be claimed for a taxpayer, spouse, or dependent. The full credit can be claimed only if adjusted gross income is below $40,000 for singles or $80,000 for married people filing jointly. The credit phases out for adjusted gross income between $40,000 and $50,000 for singles ($80,000 and $100,000 on a joint return). No credit can be claimed if adjusted gross income is over $50,000 for singles (or $100,000 on a joint return). A married person filing a separate return cannot claim the credit. The credit cannot be claimed for more than two years for each student. The credit is not refundable. That is, if you have a tax bill of less than $1,500 you can reduce it to zero, but the government won't send you the remaining amount of tax credit as a refund. Lifetime Learning This provides a tax credit of up to 20% of up to $5,000 of allowed expenses ($1,000 per tax return) for the cost of tuition and fees for any college, graduate school, or vocational training. The credit can be claimed for a taxpayer, spouse, or dependent. The full credit can be claimed only if adjusted gross income is below $40,000 for singles or $80,000 for married persons filing jointly. The credit phases out for adjusted gross income between $40,000 and $50,000 for singles ($80,000 and $100,000 on a joint return). No credit can be claimed if adjusted gross income is over $50,000 for singles (or $100,000 on a joint return). A married person filing a separate return cannot claim the credit. The credit is not refundable. That is, if you have a tax bill of less than the amount of the available credit you can get it down to zero, but the government won't send you the remaining amount of credit as a refund. Unlike the Hope scholarship, there is no limit on the number of years you can claim this credit. You cannot take the Lifetime Learning Credit and the Hope Credit for the same student in the same year, but you can claim the Lifetime Learning Credit for any other eligible student. For example, if your child begins college and you take a graduate course, you can elect the Hope credit for your child and the Lifetime Learning Credit for yourself. By the year 2003 the credit will have increased to a maximum of $2,000 (20% of up to $10,000). ADJUSTMENTS TO INCOME An adjustment to income is a deduction from your income with no strings attached. The deduction is subtracted directly from your income on page one of your tax return in the "adjustments" section. Interest on Student Loans Another educational benefit is a deduction for interest paid on student loans. Whoever makes the loan payments -- either the parent or child -- can take the deduction for the first 60 months of repayment. Because this deduction is an "adjustment to income," it can be taken whether or not you itemize deductions on Schedule A. Schedule A is the tax form on which you deduct personal expenses such as mortgage interest, property taxes, and medical insurance. Because many IPs use a good part of their mortgage interest and property taxes as business office-in-the-home deductions, and they also deduct part of their medical insurance as an adjustment to income, they often miss out on the advantages of a Schedule A. Being eligible for a student-loan interest adjustment is one of the rare instances when the IRS hasn't left IPs out in the cold. This adjustment provides a deduction of up to $1,000 per tax return for interest paid. The allowable deduction began in 1998 at $1,000 and increases in $500 annual increments to $2,500 in 2001 and thereafter. The adjustment phases out for adjusted gross income between $40,000 and $55,000 for singles ($60,000 and $75,000 on a joint return). No adjustment can be claimed if adjusted gross income is more than $55,000 for singles (or $75,000 on a joint return). Withdrawals from IRAs In the effort to smarten up America, the government has made some money available to you. It's your own money but, hey, that's better than no money. Angelo Auto Repair doesn't have enough cash available to take a collision repair course at the community college because he used all his back-up capital for a new lift. No problem: Angelo can withdraw the funds from his Individual Retirement Account (IRA), without penalty. Generally, money withdrawn from an IRA before the taxpayer reaches the age of 59 1/2 is subject to a l0% early withdrawal penalty tax. Recent federal legislation has eliminated that penalty if the money -- any amount -- is withdrawn specifically to finance higher education for the taxpayer, spouse, child, or grandchild. You don't get away scot-free, however. The money withdrawn remains subject to the income taxes that would normally be due on it. If Angelo had his retirement funds in another type of pension plan, such as an old 401(k) or a KEOGH, he could not withdraw the money without penalty. He could, however, roll the funds from one of those pension plans into an IRA, and then withdraw the money for school, from his new "rollover IRA," penalty-free. EDUCATION IRA One final item on education and taxes: If, after taking the collision repair course, the money were to start rolling in for Angelo, and if he wanted to set some aside for his child or grandchild, he could contribute up to $500 each year to an Education IRA for a child under age 18. Contributions to an Education IRA are not deductible, but amounts deposited in the account grow tax-free until withdrawn. Withdrawals from an Education IRA are tax-free if they are used to pay the child's higher-education expenses. If not used for education of the child, the money can be rolled over to the Education IRA of other family members. Perhaps a future IP? The Downside: Angelo's child or grandchildren cannot take the Hope or Lifetime Learning credits in any year in which money is withdrawn from an Education IRA. And, when determining the amount of eligibility to which a student is entitled, college financial aid officials will count Education IRAs as assets of the student. Eligibility to contribute to an Education IRA phases out between $95,000 and $110,000 in adjusted gross income for singles and between $150,000 and $160,000 for joint returns. The details of education benefits are complicated. Depending upon which tax benefit is put to work, the term "education expenses" may or may not include: tuition fees room board books equipment transportation travel So read the fine print, and check with your tax advisor. (c) 2000 June Walker. All rights reserved. We'd love to hear your feedback about this column, or put you in touch with June Walker if you like. You may also like to see her biography.