Today, there are a growing number of primary and secondary students who are being educated outside of the public school system. Alternative education includes home schooling, private schools, and tutors. There are many personal and financial factors that impact a parent’s decision about a child’s education. The choice can raise tax issues that should be recognized.
Home schooling
Today there are an estimated 1.77 million students being home schooled nationwide, according to U.S. Department of Education (http://www2.ed.gov/about/offices/list/oii/nonpublic/statistics.html). Parents assume the responsibility for educating their children at home for a variety of reasons, including concerns about the environment of schools and dissatisfaction with academic instruction.
Deduction for home schooling costs. While educators could deduct $250 of out-of-pocket classroom costs as an adjustment to gross income, parents who home school their children are not treated as educators for this purpose (Code Sec. 62(a)(1)(D); 2014 IRS Publication 529, page 4). Note: This deduction expired at the end of 2014 but could be extended for 2015 and beyond.
Impact on alimony and child support. Child support is not taxable to the parent who receives it on behalf of a child; alimony is taxable (assuming it meets the tax law requirements) (Code Sec. 71). When a single payment is made to cover both child support and alimony and the amount of the payment changes, it is not always easy to determine whether there been a reduction in child support or alimony.
A reduction in child support results when there is a reduction in the designated amount or when there is a reduction that depends on the occurrence of a contingency related to the child (Code Sec. 71(c)(2)). Examples of contingencies include the child reaching a specified age or income level, the child leaving school, marrying, leaving the parent’s household, or beginning work. However, in a recent case the Tax Court concluded that ending home schooling is not a contingency related to the child (Wish, TC Summary Opinion 2015-25). In the case, the parent stopped home schooling so she could return to the workforce for financial reasons; the child then went to public school. Thus, the reduction in the monthly amount was not related to child support. As a result, the parent making the payment had a smaller tax deduction for the reduced alimony payment.
Private schools
Almost 4.5 million students are in private schools, according to the U.S. Department of Education (http://www2.ed.gov/about/offices/list/oii/nonpublic/statistics.html). Again, a variety of factors come into play in deciding to send a child to a private school, including the opportunity for academic excellence, the need for unique training (e.g., help for special needs child), family scheduling, and other personal reasons.
Scholarships. Scholarships to pay for private primary or secondary education are tax-free (Code Sec. 117). However, this exclusion applies only to tuition and fees; it does not apply to room and board, books, travel, and other costs covered by the scholarships (Code Sec. 117(b)(2)).
Medical expense deduction. A child with a special physical, mental, or emotional condition may attend a private school able to treat the condition. The cost of attendance (tuition, room and board, special counseling, etc.) may be a medical expense that can be deducted as an itemized deduction (Code Sec. 213(d)). Examples of conditions for which educational costs become a deductible medical expense:
• Dyslexia (Letter Ruling 200521003)
• Epilepsy (Shidler, 30 TCM 529 (1971))
• Hearing impairment to learn lip reading or visual impairment to learn Braille (see IRS Publication 502)
• Hyperactivity (Newkirk, CA-6, 611 F.2d 373 (1979))
To qualify as a deductible medical expense, the school must have a professional staff competent to provide help for the child’s condition. Also, the principle reason for attendance is medical care (not ordinary education). Finally, the schooling must be recommended by a physician to address the child’s condition.
Using Coverdell ESAs. Coverdell Education Savings Accounts are savings programs that can be used for any level of education. Distributions from Coverdell ESAs are tax-free when used to pay qualified education costs for primary or secondary school (Code Sec. 530(d)(2)(A)). This is in contrast to other education breaks, such as the American opportunity credit and the above-the-line deduction for tuition and fees, that are restricted to higher education.
The exclusion for distributions from Coverdell ESAs can be used to pay tuition at private school, including a religious school and extended day programs. Other qualified expenses include books, tutoring supplies, special services for special needs beneficiaries, computers and peripheral equipment, Internet access, transportation, and uniforms (Code Sec. 530(b)(3)(A)).
Note: Up to $2,000 can be contributed annually to a beneficiary’s Coverdell ESA until the beneficiary reaches age 18; the contribution is not tax deductible. However, contributors cannot have modified adjusted gross income (MAGI) over a threshold amount. The MAGI limit for making a full contribution is $95,000 for a single taxpayer ($190,000 on a joint return) (Code Sec. 530(c)). The $2,000 annual contribution limit phases out for MAGI up to $110,000 for a single taxpayer ($220,000 on joint return); no contribution is allowed for a taxpayer with MAGI over this amount. The MAGI threshold is not indexed annually for inflation as are so many other MAGI thresholds.
Gifts from grandparents. Usually a gift is free from federal gift tax if it is below the annual gift tax exclusion amount (e.g., $14,000 in 2015). However, gifts in any amount can be made directly to an educational institution to cover the cost of tuition (Code Sec. 2503(e) (2)(A)). Utilizing the direct transfer gift option does not limit the ability to also make a gift to a child or grandchild up to the exclusion amount.
In one instance, grandparents prepaid the cost of private school for two grandchildren (for preschool through grade 12). The IRS said this transfer was tax-free for gift tax purposes (Technical Advice Memorandum 199941013). This conclusion was premised on the fact that the school would retain the prepayment if the children ceased attending the school for any reason.
Tutoring
A child may require academic tutoring or special educational assistance. Generally, there is no tax break for such cost; the parent must bear this out-of-pocket expense. However, distributions from a Coverdell ESA can be used for these expenses (IRS Publication 970). Note: There is no guidance on whether tax-free distributions from Coverdell ESAs can be taken to cover the cost of SAT preparation courses and other similar courses, but a good argument could be made that the cost would be a qualified educational expense.
ABLE accounts
Special savings accounts under state programs can be set up for a beneficiary who is blind or has a disability that occurred before age 26 and who is (1) receiving Social Security disability income or Supplemental Security Income (SSI) or (2) has a disability certification from the IRS (Code Sec. 529A(e)(1)). Created by Tax Increase Prevention Act of 2014 (P.L. 113-295) and modeled after 529 education savings plans, the Achieving a Better Life Experience (ABLE) accounts can be used to pay for qualified disability expenses, which include education (Code Sec. 529A(e)(5)).
The purpose of ABLE accounts is to allow for savings to cover the special lifetime needs of some individuals. The funds in the account are not taken into account for determining assistance under federal programs (e.g., Medicaid, SSI). However, once the account balance reaches $100,000, SSI can continue but distributions from the account are suspended.
Anyone can contribute to a beneficiary’s ABLE account up to the annual gift tax exclusion. However, unlike in the case of 529 plans, there is no special rule allowing ABLE contributors to contribution five times the annual exclusion in a single year.
States had until June 19, 2015, to submit plan designs for their programs to the Treasury. The IRS issued some guidance on ABLE accounts (Notice 2015-18, IRB 2015-12, 765) which makes it clear that at all times the beneficiary is the owner of the account. If someone else has signature authority over the account, such person may not acquire a beneficial interest in the account and must administer the account for the benefit of the designated beneficiary.
Conclusion
While a public school education is available to all children in the U.S., there may be reasons for parents to opt for alternative education solutions. Tax laws may come into play in handling the costs of nonpublic education.
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