Hope Scholarship; Child Credits; and Annual Gifts

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper, July 12, 1998

Copyright 1998 Robert L. Sommers, all rights reserved.

Question: We currently qualify for the new Hope Scholarship. If I receive a loan from my employer and also use our IRA funds to pay for my child's college expenses will these sources disqualify us from using the Hope Scholarship?

Answer: No. When you qualify for the Hope Scholarship, you may add funds from your traditional IRA and loans from any source, without penalty. The Hope Scholarship is a tax credit of up to $1,500 each year (100% of the first $1,000 of expenses and 50% of the next $1,000) to help families pay for the first two years' of post-secondary schooling at an "eligible institution." This scholarship is strictly limited to tuition and fees for attendance. Eligibility phases out for individuals with adjusted gross income ("AGI") between $40,000 to $50,000 and joint filers with AGI between $80,000 to $100,000. AGI is increased by income earned outside the U.S., including Puerto Rico, and in U.S. possessions.

You may use your IRA funds or loan proceeds to pay for tuition and fees, then claim a tax credit on your return. Remember, your IRA withdrawals will be taxed as ordinary income, but you'll avoid penalties.

In general, an eligible institution is an accredited, post-secondary school offering credit towards a bachelor's degree or an associate's degree.

The Hope Scholarship credit is elective and non-refundable (you cannot get money back from the IRS). Also, the credit is not available if the same student in the same year is receiving distributions from an Education IRA or using the lifetime learning credit. Note: The lifetime learning credit is equal to 20% of the first $5,000 ($10,000 in 2003) of certain education costs.

Question: With joint income of $70,000 and children ages 16 and 12, do we qualify for the new child credit?

Answer: Yes. Commencing in 1998, there will be a $400-per-child credit ($500 in 1999) for children under age 17. However, the credit phases out for an AGI of $75,000 for individuals and $100,000 for couples. These thresholds are not indexed for inflation.

The phase-out rate is $50 for each $1,000 over these thresholds. In other words, an individual with one child will lose $250 of the credit for an AGI of $80,000 ($5,000 over the $75,000 threshold = 5 X $50 = $250).

Low-income families earning at least $18,000, but who pay little or no tax, will receive the benefit of the per-child credit as a refund. Note: Certain low-income taxpayers may be able to claim both the Earned Income Credit and some Child Tax Credit (both refundable credits), depending on their earnings and the number and ages of their children.

Question: My wife made $10,000 cash gifts to six different friends this year. If we sell stock at a profit, may we deduct the $60,000 in gifts against our profit?

Answer: No. The income tax system, which taxes ordinary income and capital gains received by a taxpayer, is separate from the gift and estate tax regime, which extracts a tax from the donor (giver) "for the privilege of passing property to another," either by a gift during life or at death. By making annual gifts of cash or property of no more than $10,000 per year per beneficiary directly to a beneficiary, a donor qualifies for the Annual Gift Tax Exclusion, but these gifts do not create an income tax deduction.

The recipient of your gift, however, could later be subject to an income tax. For example: If you make a gift of stock to your niece worth $10,000 with a $2,000 basis (usually your purchase price), she carries over your basis (your basis and holding period for capital gains becomes hers). If she sells the stock for $10,000, she'll have an $8,000 income tax gain. If she is under age 14 when she sells it, she'll be taxed at her parent's tax brackets.


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