ch 8

7. Define a Coverdell Education Savings Account (ESA).

A Coverdell ESA is a tax deferred trust or custodial account established to pay for higher education or qualified elementary/secondary school expenses. Qualified higher education expenses include tuition, fees, books, room, board, and computer related expenses. Distributions from a Coverdell ESA for qualified education expenses are tax free as long as the distribution does not exceed the qualified education expenses, reduced by any financial assistance.

10. Discuss tax deductions / tax credits restrictions as pertains to education expenses.

A taxpayer is not allowed to receive a double benefit for the same qualified education expense. For example, a taxpayer cannot claim both the AOTC and Lifetime Learning Credit for the same child in the same year or for the same qualified education expenses. A taxpayer cannot claim the AOTC or the Lifetime Learning Credit for the same expenses that were paid from a 529 Savings Plan or a Coverdell ESA. The taxpayer cannot claim the AOTC or Lifetime Learning Credit for the same expenses covered by a scholarship, grant, or employer-provided education assistance.

2. Distinguish the difference between an educational grant and an educational loan.

An educational grant is money provided to students for postsecondary education that does not require repayment. Grants are typically awarded based on financial need and are provided by the federal government for undergraduate studies only. Some educational grants include the Federal Pell Grant, TEACH Grant and FSEOG Grant. An educational loan must be repaid and is offered by the U.S. Department of Education as well as colleges and universities. Most loans are not based on financial need (note that the Federal Perkins Loan and the Subsidized Stafford Loan are need-based loans).

1. List and define the three methods used to determine the Expected Family Contribution (EFC) for financial aid. .

Methods include: • The regular formula: income and assets - considers a family's income and assets and is the for- mula that is used most for families. • The simplified method - does not consider the family's assets and instead reviews the income tax return (1040A and 1040EZ filers in tax years prior to 2018) and specifically considers total adjusted gross income of less than $50,000. • The automatically assessed formula - The EFC is determined to be zero. Tax forms considered include 1040A and 1040EZ (in tax years prior to 2018), and the adjusted gross income is $26,000 or less.

12. Explain the disadvantages to using UGMA / UTMA accounts to fund a college education.

Once a child reaches the age of majority, he can use the assets in the UGMA/UTMA for something other than a college education. The account custodian, or parent, will be unable to control the asset to ensure the funds are used for a college education. In addition, the UGMA/UTMA may cause a kiddie tax issue where unearned income is taxed at the income tax rate for trusts and estates.

3. List the repayment options for a Stafford Loan

Options include: • The standard repayment schedule will amortize the loan for up to a 10-year period of time. • The extended repayment schedule allows borrowers with more than $30,000 outstanding in either FFEL Stafford or Direct Stafford Loans to repay the loans over a period of time not to exceed 25 years. 2 © MONEY EDUCATION CHAPTER 8: END OF CHAPTER SOLUTIONS / INSTRUCTOR USE ONLY • The graduated repayment schedule allows borrowers to repay the loan for up to 10 years (30 years for consolidation loans) with initial low payments that increase every two years. • The Income Based Repayment (IBR), Pay As You Earn (PAYE), Revised Pay As You Earn (REPAYE), and Income Contingent Repayment (ICR) schedules cap the monthly payment based on the bor- rower's income and family size.

4. What are the two types of PLUS Loans?

Parent PLUS Loans allow parents to borrow to help pay for a dependent's undergraduate education expenses. PLUS Loans are not based on financial need. PLUS Loans for graduate and professional degree students are also not based on financial need and are available for student's seeking graduate and professional degrees.

6. Define the two types of qualified tuition plans.

Prepaid tuition plans allow a parent to purchase college credits today and use those credits when the child attends college. Prepaid tuition plans only pay the cost of tuition, not room and board. College Savings Plans (529 Savings Plan) allow for college savings on a tax-deferred basis with student attendance at any eligible education institution as long as they are used to pay for qualified education expenses [tuition and fees, books, supplies and equipment (room and board may also be included)]. Up to $10,000 per year may be distributed tax and penalty free to pay for public or private elementary or secondary school tuition.

11. Discuss the differences between scholarships and fellowships.

Scholarships are awarded to students to assist with the payment of education related expenses and are available for both academic and athletic achievements. Scholarships are awarded to both undergraduate and graduate students. Fellowships are typically paid to students for work, such as teaching while studying for a Master's degree or conducting research while working towards a Doctorate degree. Fellowships can last anywhere from a few weeks to a few years depending on the depth and level of work involved. If a scholarship or fellowship is intended as compensation for past, present, or future services, then it is included in taxable income.

9. Distinguish between the American Opportunity Tax Credit and the Lifetime Learning Credit.

The American Opportunity Tax Credit (formerly the Hope Scholarship Credit) provides a tax credit of up to $2,500 (2019) per student for the first four years of qualified education expenses for postsecondary education. Since the credit is per student, a family with multiple children in the first four years of college may qualify for multiple credits in one year. The Lifetime Learning Credit provides a tax credit of up to $2,000 (2019) per family for an unlimited number of years for postsecondary education or for any course of instruction at an eligible educational institution to acquire or improve job skills of the individual.

5. What are the consequences for defaulting on student loans?

The borrower's credit rating will be negatively impacted, the borrower's wages can be garnished, and state and federal income tax refunds can be withheld and applied to outstanding loans in default.

14. List and briefly describe the four primary methods for calculating the amount needed for education funding.

The four primary methods for solving an education funding calculation are: • Uneven cash flow method: This method has two steps and works for any type of education funding situation. First the net present value of the cash flow stream in today's dollars is determined. Then the annual savings required to fund the education goal is calculated. The uneven cash flow method is the best approach to use in calculating education funding for multiple children. • Traditional method: The traditional method of education funding uses real dollars and the annuity due funding plan to calculate the present value of the cost of education. • Account balance method: The account balance method is a three-step approach that determines the lump sum amount needed when the child starts college and how much must be saved to attain that lump sum amount. The method assumes that savings will stop when the child starts college and begins withdrawals. • Hybrid approach: The hybrid approach contains a three-step calculation and combines the con- cepts of the uneven cash flow and account balance method. This method is used the least because the ordinary annuity concept can be confusing to the first-time learner.

8. Discuss a tax advantage to the student loan interest deduction.

The student loan interest deduction is taken on the income tax form before adjusted gross income (above-the-line deduction). The deduction reduces taxable income and is available whether or not the taxpayer itemizes deductions (itemized deductions are taken after adjusted gross income or below- the-line). The student loan interest deduction allows up to $2,500 of interest expense deduction per year.

13. Discuss the features of a nontaxable employer-provided education assistance program.

Up to $5,250 (2019) per year reimbursement by an employer for an employee's education expenses is allowed. Any education expenses reimbursed above $5,250 are included in the employee's income. The education expenses may or may not be directly related to the employee's current job duties depending on the employer's policy. To qualify for the tax-free reimbursement of education expenses, the employer's education assistance program must be in writing, and the reimbursement must be for tuition, fees, books, supplies, and equipment.