PODCAST: Tax Breaks for College Finance with Kalman Chany

Paying for (ever-pricier) college is a challenge that this consultant meets head on with highly specific guidance.

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David Muhlbaum: Paying for college as tuition and other expenses continue to rise is a challenge for many families. Paying for college is a huge, complicated topic as well. So, today, we’re going to focus on a way we can be helpful, which is pointing out the tax breaks that can ease this financial burden, whether college is something you’re saving for in the future, paying tuition bills on right now, or still carrying debt from. We’re going to get some expert help from Kalman Chany, author of The Princeton Review’s Paying for College. Also, a quick look at postal rates for the holiday season. All coming up in this episode of Your Moneys Worth. Stick around. Welcome to Your Moneys Worth. I’m kiplinger.com senior editor David Muhlbaum joined by my co-host, senior editor Sandy Block. How are you doing, Sandy?

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Sandy Block: I’m great. I’m headed for the pool soon to enjoy this sunny August weather.

David Muhlbaum: Well, good for you. Enjoy the dog days. As far as I’m concerned, summer is over. Not by the calendar, I understand that, but a week or so ago, I saw something that to me indicates there’s a fork stuck in summer: Mums for sale at the hardware store.

Sandy Block: Oh, that’s your marker? I used to use back-to-school sales, but now those start in May or June, and that’s just ridiculous, but I actually have seen displays of Halloween candy at the Safeway.

David Muhlbaum: Yeah. There was a rumor that there was going to be a candy shortage, but no, that didn’t pan out.

Sandy Block: I’m not seeing it.

David Muhlbaum: ... no. Well, okay. I got another one for us. The United States Postal Service has filed for a holiday rate increase for package shipping.

Sandy Block:

Right. Because they can’t just run off and change their rates like UPS or FedEx. They have to get approval from the Postal Regulatory Commission or something like that. But what’s that got to do with summer ending?

David Muhlbaum: Well, two things really. Number one that they said peak holiday season in August, which I guess I find triggering, but also the range of what they consider holiday season. These increases will go into effect between October 2nd and January 20th, 2023.

Sandy Block: Okay. So, I guess the four-month holiday season.

David Muhlbaum: Yeah. What holidays are we including here?

Sandy Block: Yeah. Guy Fawkes Day? I don’t know. But, well, it seems excessive, but I guess the postal service is still a little shell-shocked from the volume they had to manage in the first couple of years of the pandemic. They’ve done this surge pricing before, right?

David Muhlbaum: Yeah, you’re right. This would be the third year. But what’s different this year, besides the actual amounts of the increase, is that period we were just talking about. They’re tacking on almost a whole month. The surge used to end on December 26th, Boxing Day.

Sandy Block: Right. I guess even if you mail your packages after the holidays, you still get hammered. You mentioned the rates, but what are they?

David Muhlbaum: Okay. It’s not a percentage thing that we can shorthand and, notably, this doesn’t have anything to do with the cost of a first-class stamp, which is what used to get people all in a lather. As is always the case, there are different rates charged to commercial shippers and retail shippers like you and me. But one that I found relatable is for flat-rate Priority Mail, which is what I tend to use, they provide the box or envelope, you fill it, weight doesn’t matter. It’s pretty convenient. But starting October 3rd, those costs will be almost a dollar more each, 95 cents.

Sandy Block: Wow. That seems like a lot. How does that compare with last year’s surge?

David Muhlbaum: Okay. I have that. Last year, that one in particular for the Priority Mail was 75 cents. But, hey, that was in 2021 dollars. Yeah. Ain’t inflation fun?

Sandy Block: Yes, it is. Unless you’re buying eggs and gas. So, the money-saving tip here, because we need one, because we’re Kiplingers and we’re actionable, is: Mail extra early for the holidays. Have your packages in the mail by October 2nd?

David Muhlbaum: You’re killing summer. Please, go swim. Okay. Coming up next, we get way deep into college finance with an expert in the field, whether you’re saving for college, paying for college or working your way out of college debt, you’re going to want to learn from Kal Chany.

Paying for College with Kalman Chany

Welcome back to Your Moneys Worth. For our main segment today, we’re going to talk about paying for college. As I hinted in the introduction, this is a big topic. So, to come away with a discussion that both fits in our time slot and is quality, actionable Kiplinger personal finance guidance, we’re planning to concentrate on what sort of tax breaks can be used to offset the cost of higher education. But our guest today, well, when it comes to college finance, he knows the whole enchilada, soup to nuts, if I can mangle a food metaphor. In fact, he wrote a book, some might say the book on the topic, it’s called, straightforwardly, Paying for College. It’s published by The Princeton Review. I’m going to turn this introduction into my first question to Kalman Chany. Here it is. So, which edition of Paying for College are we on now, Kal?

Kalman Chany: Okay. Currently there’s the ‘22 edition. The 2022 edition is out. And the 2023 edition though, that will be published on September 20th. So, anyone who’s interested in getting the book, they could even pre-order now (opens in new tab). That would make sense, because there have been a lot of changes that have gone on in the whole college funding landscape. So, there is a lot of new information we have. Even beyond that, though, the book has a free update service, because from the time we went to press, about a month ago, and it’s now with the printers and getting shipped, there’s been a lot of new information. So, we’re working on the update now to have that ready to go by September 20th.

David Muhlbaum: So, I’m holding in my hand here the 30th edition and we’re going to get the 31st edition. It’s interesting that you’re doing these running updates, because 30 years ago, that was before the internet was really a thing. It’s interesting how you’re meeting that challenge, because these days every Joe or Jane with a blog is presenting themselves as a college expert.

Now, in all honesty, I haven’t read all of your book. I read the fun parts? I definitely read the part where you laid out the underlying philosophy of your approach. You lay out who the players and the processes are. Also, I guess, kind of the moral questions: Is this fair? Is this legal? Is this ethical? But listeners shouldn’t take the fact that I didn’t finish Kal’s book the wrong way, because some of those sections I skipped are these really detailed ones that are basically a line-by-line walkthrough of the forms such as the Free Application for Federal Student Aid, which everyone calls FAFSA, that you would need to fill out if you’re filing for financial aid. Then, I bounced around to look at the tax angles, because that’s how we’re going to try to focus today. But a little bit more about you, if you please, Kal, you are the president of Campus Consultants, Inc. So, what’s that?

Kalman Chany: We’re a Manhattan-based financial aid advisory forum that guides families worldwide on how to maximize their eligibility for financial aid and minimize college costs. The book is based on my experience counseling thousands of families over the past 30-plus years on how to navigate the financial aid process and the college funding landscape.

Sandy Block: Well, thanks for joining us, Kal, I know back when I worked at USA Today, you were really the go-to guy for us whenever we wrote about paying for college, all of the intricacies of financial aid. I guess I’m going to take credit here for the idea of keeping us on taxes as a subset of the totality of knowledge you have to share, because it’s something I wrote about recently for Kiplinger’s Personal Finance magazine (opens in new tab).

But I want to echo what David was saying, which is that college finance is a huge and complicated topic. Even when we try to say we’re just going to talk about tax breaks. It’s very hard not to get pulled into sometimes what seems like an entirely parallel accounting system. Even people like me, who think we have a pretty good handle on the federal tax system, end up looking into college finance and see something that makes you realize that traditional good tax guidance and optimizing your finances for college can be at odds. So my question then, Kal, is maybe you could start by telling us what do you think is the biggest tax mistake people make that may hurt them when it comes to paying for college or getting aid for college, the whole landscape there?

Kalman Chany: Okay. The biggest problem is, and the biggest financial aid trap is having money in the child’s name. There are some tax advantages, for example, of having funds in a custodial account or, in some cases, even setting up a trust fund. But those are financial aid traps, because money in the child’s name, a custodial account, a trust fund, even if the trust is not available to the child to say 35 years of age, those are assessed as assets and student assets in the aid formula are assessed far more heavily than parental assets.

For example, an extra $10,000 in assets in the parents’ name would reduce the aid at most $565. But that same $10,000 in the child’s name can reduce the aid by $2,500. That’s just for one year. Some schools will say, "If you start with the $10,000. We’re going to take four of those $2,500 chunks over the four years your child’s in college." Basically, having that money in your child’s name didn’t help you in terms of paying for college, because you as a family are still expected to pay as a parent toward college. So, if you want to have any hope of getting need-based aid, and in the book we cover how you can get an idea of doing that, there are worksheets, etc., you want to avoid putting money into the child’s name in custodial accounts.

Sandy Block: Right. I think to follow up on that, Kal, people probably do that because they think they’re getting a tax advantage by having their investments in a child’s account. But you’re saying this can backfire when it comes to financial aid. What about, a question I often get, I know that 529 plans do offer tax advantages, which maybe you can discuss. But I often hear from people who worry that if they put that money in a 529 plan, that will hurt their child’s chances for financial aid. Can you talk about that a little bit?

Kalman Chany: Sure. That’s a big mistake that people have. Certainly, in the book we are saying people should be saving for college. The key though is putting the money into buckets that don’t get assessed that heavily. So, whether you have money in a 529 plan that you own as a parent for the benefit of your child, and that’s the way it should be set up, generally, or you have the money in a bank account in our own name, it’s going to get assessed the same way. There are tax advantages of putting money into the 529 plans. Those are the qualified state tuition programs, where the funds grow tax deferred. If you use the funds then to pay for qualified higher education expenses, tuition and fees, room and board, if you use the money for that, then you never pay tax on any of the increase in the value of those plans.

In some states, for example, my home state of New York, if you put money into a 529 plan, married, filing jointly, up to $10,000 of that contribution for the year is deductible on your state and local tax return. Other states might match some of the funds. So, you want to always first look at what plan is in your own state, but you should not view this assumption that if I just spend every nickel and don’t have anything and don’t set any money aside, I’m going to be hurt in the aid process, because some of the aid is going to be loans.

The school may not meet your need in full. In other words, you might demonstrate eligibility, but the school might not meet it. So, having funds in a 529 plan is great. The big mistake though people make, when they fill out the forms, is they think, "That’s my child’s asset." They don’t realize they’re looking at who owns the plan. Generally thinking you want to have that as the parent, you as the parent own the plan for the benefit of the child and therefore then it’s to be listed on the aid form as a parent asset. It would be a mistake to list as a student asset.

David Muhlbaum: Right. So, even if the parent correctly sets this up as they being the owner and the child is the beneficiary, which I think is pretty much how everyone does it, it seems odd that you’d make that mistake of putting in the child’s name. When it comes time to actually filling out the aid form, they don’t allocate it correctly. They assign it to the child rather than themselves.

Kalman Chany: Right. Right. They don’t correctly list that. That’s one of the problems with the aid forms and the process is that they will catch things you do that result in you getting too much aid, the audit process. But they don’t correct things and ask you and tap you on the shoulder and say, "Oh, you listed this wrong. You didn’t classify this properly. You misclassified it." So, it’s very important that you don’t view the process of paying for college and going through the aid process as — you get a participation award. There are no participation awards just for filling out the form. But that’s how it’s branded. That’s how the process is branded.

To understand the high school is under pressure, if you’re in a public high school, from their administrators ,to get kids just to fill out the forms as soon as possible and get them in, because the high school is getting monitored by the federal government for how many kids in that high school fill out the form. Now, if a school district has 100% of the kids fill out the FAFSA form, but nobody gets any money, that’s a successful process for that school district. But for your case, it’s not very successful. So, you have to realize how the game is to be played and that a lot of the information is biased in favor of other people’s agendas, not yours.

David Muhlbaum: You brought up, you mentioned the word audit in there and I’m going to hang on that, because it actually is a way to reveal the parallels or this idea that we broached of the parallel tax system. You have the one, you have the sort of federal and state system by which a portion of your income is sent to pay for the government, basically. Then there is this other parallel system where your income and assets are analyzed for how much aid you can receive, the college aid process. If I understand correctly -- well, what I do know about the federal system is your chances of getting audited are way low. What I understand from the aid system is that your chances of getting audited are way high. I was hoping you could talk a little bit more about that and how people can understand it and in part not be alarmed by it.

Kalman Chany: In terms of the financial aid process, they don’t use the term audit. They use a term called verification. There’s federal verification. There’s also institutional verification. The federal process, though, with the FAFSA, 35% of the applications are selected for verification. It tends to be people who are eligible for federal grants, such as the Pell Grant, are more likely to be selected. But there are some strategies you can use to minimize the chances you’re going to get selected for verification. That would be in part doing the form online at fafsa.gov. And the new form for ‘23, ‘24 year aid will be coming out October 1st.

David Muhlbaum: Now, Kal, you mentioned the detail that’s in your book about this kind of process, but even so, I want to give it another plug and I’m going to wave it around here and say that when you’re sitting there going through the process, big chunks of this book are like having Kal over your shoulder going, "Yeah, do that. No, don’t do that." With remarkable precision about the process. That is a reassurance and a case in which I can just say, "Look, it’s in the book."

Kalman Chany: People compare me to a Marine drill sergeant.

Sandy Block: But that’s what you need.

David Muhlbaum: I envisioned three groups of people that we’re speaking to here today. We’ve kind of covered one of them, which is, in brief, we’ve covered saving for college. Really, the short answer there is: 529 plan. Then, we’re talking about what tax advantages are available to people who are paying for college. Basically whatever savings they’ve done, they’ve done. They’re on the hook, the kid’s at school-

Sandy Block: Right. Paying the bills.

David Muhlbaum: ... they’re paying the bills. The need has been sorted out. What does the federal tax code have to help?

Kalman Chany: Okay. The federal tax code has a variety of tax credits and other tax benefits that families can use or students can use if they’re independent, they’re an older student going to college, which is a growing demographic, to help pay for college. That’s also considered even financial aid. The biggest ones are the tax credits, specifically the American Opportunity Credit. That allows families, married filing jointly income of $160,000, up to that point, you can get the maximum credit. It phases out at $180,000. For a single or head of household, it’s going to start phasing out at $80,000 adjusted gross income. And totally phase out at $90,000 adjusted gross income.

This is very valuable because it’s a credit, which is much more valuable than a deduction, because a credit will save you on your taxes, dollar for dollar, by the amount of the credit you get, you can get up to $2,500 in a credit. If you have tax liability, you can get up to that, because up to $1,500 is to offset your tax liability. But even if you have no tax liability, you’re low income, but you have qualifying expenses, you can get up to $1,000 as a refundable credit, even if you have no tax liability. That’s very attractive to get.

Now, some people are of course saying, "Oh, those income levels are low. I’m not going to qualify. I have very high income. I’m making $500,000, $600,000." Well, at a certain point in the federal tax code, claiming the child is a dependent on your tax return gets you no benefit. In the past, it’s been $400,000. I don’t know going forward, that’s something you want to check and see about that. Because if there is no benefit to claiming your child on the tax return, don’t claim them.

The child can’t claim themselves. But then that child themselves could file a return, even if they have no income. In many cases, they can get $that 1,000 refundable credit. So, the parent isn’t getting any tax break. Even if they are, they’re getting only $500 for putting the child on there. They could get $1,000 with the credit. So, you have to balance your tax planning, overall, what your accountant’s telling you sometimes with this aid planning and point that out to the accountant, "I had a child." Now, the big mistake with those credits, though, is schools send out these forms called 1098-Ts. Don’t use them. Even the IRS guidance in Publication 970 says they may be wrong for indicating how much you’re paying toward college.

Because a big mistake many colleges do is they put down what you paid for the full term. For example, your child’s a first-year student, what you had in tuition expense, but they put down the whole year’s aid. So, it looks like you got more aid than what the tuition was for the full term. So, your accountant sees that and says, "Well, you didn’t pay anything. You don’t get the credit."

David Muhlbaum: Oh, Lord.

Kalman Chany: But even if you’re fortunate enough to be in a situation where, for that term, you had more grant money than you had tuition expense, all is still not lost, because as the IRS points out, you could claim some of that scholarship as taxable income on your child’s tax return, who gets over $12,000 as a standard deduction. So, may not pay any tax on that by reporting it. But then that means you have qualified expenses you can use for the tax credit. Again, this is rather complicated. That IRS Publication 970 goes over all the benefits, that’s freely available at irs.gov, that’s dozens of pages long. So, in our chapter called "Less Taxing Matters," we just say, "This is not a tax guide. There’s more detailed information, but these are some things you can get." So, there are certain tactics, strategies you can use, but you have to be aware of them and understand the fine print. And it’s a somewhat counterintuitive process.

Sandy Block: Well, and Kal, can you just talk briefly about the Lifetime Learning Credit, which I think has more value for graduate students?

Kalman Chany: Okay. The Lifetime Learning Credit, that’s another type of tax credit. Now, there has been a recent change with that. So that now the income limits that I discussed earlier for the American Opportunity Credit are the same income limits to qualify for the lifetime learning credit-

Sandy Block: Which are higher than they used to be. Right?

Kalman Chany: Yes.

Sandy Block: Yeah. That’s good.

Kalman Chany: Yes. Significantly more. They used to be like $110, $120 .... But now it’s, again, $160 married filing jointly up to $180,000 and then it phases out at $180,000, the AGI. $80,000 single or head of household. Married, filing separately, you’re not eligible for those tax credits. That’s something to be aware of, if you’re filing married, filing separate returns, you’re not going to be able to get those tax credits. But the Lifetime Learning Credit, that’s a 20% credit up to the first $10,000 of tuition that paid. But with the lifetime learning credit compared to the American Opportunity Credit, it’s a non-refundable credit. It can only be used against your tax liability. So, unlike the American Opportunity Credit, where I said you can get up to $1,000 if you have no tax liability, the American Opportunity Credit can only be used to offset tax liability that you have.

That doesn’t mean your refund or what you owe Uncle Sam on April 15th. But that means after you deduct your standard deduction from your adjusted gross income and take other deductions, if it says on the tax tables or the tax charts that you have a certain amount of taxes that need to be assessed on your income -- you may not pay them, because you may have over-withheld, but if you have tax liability, then you can claim up to $2,000. But that also is a per filer credit. In other words, if you have multiple children in college with the American Opportunity Credit, you can use that, if you have three in college and you haven’t filed for bankruptcy yet, you could use that to offset your tax liability or even get that $1,000 refundable credit per child. The Lifetime Learning Credit, whether you have one in college, two, three, four in college, doesn’t matter, it’s only up to $2,000 per tax filer.

Sandy Block: Right. But just to make clear, Kal, isn’t the point here that the American Opportunity Credit is only available for the first four years of full-time college. Whereas the Lifetime Learning Credit, you can claim late. Isn’t that the big difference between those two? I just want to make that distinction.

Kalman Chany: Right. The American Opportunity Credit is for undergraduates, but it’s important to even realize there that the four years of college are going to overlap five tax years if you start in the fall. So, it’s possible to get four years of the American Opportunity Credit and then do the lifetime learning credit. Now, you might blow that, and that’s because some schools may want tuition paid for that last semester before you burn the bill and you’re done with them. They might say, "We want that money in December." That’s a problem because you got to pay the money in the tax year to claim the credit. A way around that then is, even if you didn’t use it before, is to go on a payment plan if it’s available, so that you’re paying some money after you sing "Auld Lang Syne" for the final semester, when your child’s in college, and then you could possibly get that lifetime learning credit for that fifth tax year.

David Muhlbaum: Right. Yeah. The incremental cost you’d pay for an installment plan would be lower than the possible upside of claiming the credit. Now, I have an in-the-weeds question about both of these credits. Both of these credit programs, the money available to you cannot exceed what you actually paid out of pocket for education?Now, that seems improbable, because $2,000 or $2,500 is not a lot of money compared to the cost of education. But in theory, you could have someone with a absolutely total full ride, who then could say, "Yeah, I’m in college. I’d like my $2,500?"

Kalman Chany: Okay. So, the way that credit works for the American Opportunity Credit, it’s 100% for the first $2,000 in qualified expenses. Those-

David Muhlbaum: Qualified expenses, bingo.

Kalman Chany: ... expenses are different than the qualified expenses to use the 529. The 529 can be room and board as well as tuition and fees. The American Opportunity Credit that is just tuition and fees, mandatory fees. That’s an important distinction there and that’s why you need to understand the fine print. However, as I mentioned a bit earlier, the wiggle around that is if you’re getting fully funded with the grant money, if you use loans, even if the child takes out a student loan, that counts as tuition paid, and a parent, if they claim the child in the return, they could claim that credit. Even if the child’s taking out a loan, if grandma pays money to the college, which there’s a no-no oftentimes doing that, but it doesn’t have to be that you as the taxpayer paid that, but they don’t let you get two tax benefits.

The problem with the grants and scholarships is normally those that they’re used for tuition are not subject to federal income taxes, they’re tax free. But the workaround around that, again, is if you’re in that fortunate position to get so much grant money, is to then claim on the student’s return some of that scholarship, enough of it, to get the tax credit. Because, again, the student gets a bit over $12,000 in a standard deduction. Let’s say they had only $3,000 in another income for the year. Well, they could claim $4,000 of that grant and scholarship they got, add that onto their tax return, their adjusted gross income, $7,000, it’s below the $12,000 plus standard deduction they get, they’re not going to pay any taxes. But by doing that, and the IRS even tells you this in the Publication 970, by doing that, then you could set yourself up to get that $2,500 credit even if the amount of scholarships you got exceeded the amount of the tuition fees that were billed.

So, you really need to understand all these little nuances. They don’t make it easy to get these benefits. The politicians love to say, "Yes, we’re doing this. We’re doing that." But you really need to understand the fine print. And then that these alternate strategies you can use, because most people would say, "I don’t want to put that on my child’s tax return." Now, people are probably wondering, "Well, that’s going to raise my child’s income. That’s going to harm me for aid." That’s not true, because any taxable aid that you report on your tax return, you get to deduct as a Title 4 exclusion on the aid forms. So, it’s backed out that extra money you report on the child’s tax return for what you’re doing to get the tax break for you as a parent, that money is backed out against the student’s income.

So, they would say, in that example, $3,000 from work, $4,000 taxable scholarship, students income for aid purposes still only $3,000. Because they’re going to take the seven, subtract the four, because you report on the return you have that. Again, you really need to know the details doing this. If you just go through it and figure out, "Well, I’ll hope for the best," and have this, you’re going to pay a lot more money in college than you have to. That’s the whole premise of the book is to raise people’s consciousness of all these different options that are available. In part, also, that you have to balance your tax planning with your aid planning, to pay the least amount of money for college.

(Editor's note: Funds withdrawn from 529 plans to pay qualified tuition and fees do not count as qualified tuition and fees paid when determining eligibility for

those education tax credits. See bottom of transcript for more detail on this important exclusion.)

Sandy Block: So, Kal, the last question we have for you, federal student loans have been on pause for a couple of years now and there’s a lot of talk about some forgiveness, but we know that a lot of graduates have a large amount of student loans. A lot of them are really struggling to pay them back. Some are getting help from their parents. Could you talk a little bit about the tax break that is available for student loan borrowers?

Kalman Chany: Okay. Yes. I can talk about that. But it’s not just the students who borrowed. In some cases, if the parents borrowed and they can demonstrate that that debt they incurred was to pay for these qualified higher education expenses, they themselves, if they’re being charged interest while the student is in school, they may be able to qualify for this tax break, and they have different income limits for that. Again, that’s in Publication 970, but basically up to a certain amount of the interest that’s been paid is going to be deductible.

David Muhlbaum: Have we said what the maximum is available?

Kalman Chany: The maximum-

Sandy Block: The deduction is $2,500, isn’t it? Yeah.

David Muhlbaum: Yes. Right. I wanted to get that number out there.

Sandy Block: The other point I wanted to make, and this is relevant for the students is I believe, Kal, this is you don’t have to itemize to claim this deduction, which-

David Muhlbaum: Oh yeah, it’s above the line. Above the line.

Kalman Chany: Right. Right. Yes.

David Muhlbaum: Yeah.

Kalman Chany: It goes generally on Schedule 1 in the adjustments to income section.

Sandy Block: So, Kal, I believe this deduction is worth $2,500 in interest and students and/or parents can claim this even if they don’t itemize on their tax returns. Is that correct?

Kalman Chany: Yes, that’s correct that they can do that. They claim, it’s somewhere else on the return. It’s not an itemized deduction that you’re able to claim. But the important thing to understand about that, students and parents, that interest, the tax filer has to have paid that interest. In other words, a parent can’t claim the student’s loan interest that the loan their child took out on their return, nor can the student on their own return claim the interest the parent paid on an educational loan they took out. It’s that the tax filer, the person filing the return, had to have paid that interest on their own loan obligation that they had, not somebody else’s loan.

Sandy Block: Well, wait a minute, let me clarify that, Kal. Say I’m a student and my parents are paying my loan. They can’t claim the deduction because I’m liable for it. But can’t I claim the deduction even if I got money from my parents to pay it?

Kalman Chany: It’s the interest that’s paid. You have to read the fine print, all of there. But the key thing there is, if the parents borrow the money, they can get that deduction on their tax return if they meet the income limits. If the student borrowed the money, even... That’s the only person who can claim that if they qualify for it on their returns.

Sandy Block: It’s the person who’s liable for paying that loan, who’s eligible.

Kalman Chany: Loan. Yes. They’re going to get a statement at the end of the tax year saying how much interest was paid to use for the purpose of that. Of course, the IRS is then going to compare those forms that people are issued with what’s claimed on the return.

Sandy Block: Right.

David Muhlbaum: But the loophole, if this is the right word, is that, let’s say the parents are giving money to the child whose name is on the loan to pay it off. The child can still claim it.

Kalman Chany: Right. The child, I believe that to be correct. But again, they should always ask their tax advisor when they’re doing things, I’m going to give the standard disclaimer, even said in the book, "We’re not in the business of giving tax advice." They should consult their tax advisor or review Publication 970, which has pages and pages about all these different breaks to be aware of. One thing though, with the loans though, and the tax break, the big tax break though is, if you are eligible, for example, for Public Service Loan Forgiveness program, and that’s a key thing to realize, because they’ve changed the rules for that and there’s a waiver now that’s going to expire on October 31st. That people who previously were denied this, can file documents with the government before trick or treat day and possibly get credit for payments they made that previously were not going to be considered.

Now, the strategy is counterintuitive with Public Service Loan Forgiveness, which is you want to pay the least amount of money on your loans during that period of the 120 qualifying payment period to get it, and extend out the repayment, because then you could possibly get more of a loan forgiven. That’s a huge tax break because when that is forgiven, normally when debt is forgiven, it’s taxable income. But Public Service Loan Forgiveness program, that’s if you work for the government, if you work for qualifying nonprofit, full time, even during the COVID pauses, you didn’t pay anything. That’s counting as qualified periods. If you have these loans, you really want to look into that and see, because you have to file things. If you have loans, old loans, that were not direct loans, but were with lenders that were federal loans, you can consolidate them, get them consolidated and then they will count all those periods back for you.

Sandy Block: So, I think this is an important-

Kalman Chany: And in some cases you can even get a refund if you had more than 120 payments. So, you really want to focus on this, because this is a once in a lifetime opportunity, but the window of opportunity is going to close soon. So, if you worked for not-for-profit and you were paying off loans simultaneously while you were working there, even if you were dinged before, there’s a workaround to get that. You can look at that Public Service Loan Forgiveness and get that document in before October 31st, the application for the qualified employers that you worked for, and if necessary consolidating the loan sooner, rather than later, to get those payments, that before wouldn’t be considered now part of the 120 qualified payment periods.

Sandy Block: To your point, Kal, because this is important and I didn’t realize this. So, you’re saying that the amount of loan that is forgiven because you qualify will not be taxable, because usually forgiven debt is treated as taxable income, but you’re saying you will not be taxed on the amount that’s forgiven.

Kalman Chany: For the Public Service Loan Forgiveness program.

Sandy Block: Yeah.

David Muhlbaum: Since we’ve roamed into the question of loan forgiveness, which is a good topic and is potentially going to affect a lot of people, this concept of a broader forgiveness, the $10,000, something like that, that has been discussed. Again, this isn’t even at the fine print state, this is at the, "Mm, I had an idea that may or may not happen." But do we know if that forgiveness would be taxable?

Kalman Chany: Generally speaking, they’ve said under that tax law that’s going to expire in 2025, that’s due to loan forgiveness will be tax free if it occurs before you sing Auld Lang Syne on New Year’s Eve of 2025, unless they agree they’re going to grandfather that provision in the new legislation, because it’s going to sunset.

David Muhlbaum: Got it.

Kalman Chany: So, we don’t know if that happens. There’s a lot of debate about that. The higher education industry is not in favor of the forgiveness. There may be a different workaround though that some people have tossed around and that is, they will recalculate the interest and lower the interest rate on these federal loans. They will then give credits toward pay off. Or if you paid it all off, give you a refund back. So, they haven’t yet decided about that what they’re going to do nor have they decided-

David Muhlbaum: Tax-free refund?

Kalman Chany: Possibly. Yeah. Because it would be return of the interest. They might say, if you claim the interest at the deduction, then you’re not going to get it. But that’s going to be so hard for the IRS to enforce that may not happen. But again, until it passes or there’s executive action, don’t count your chickens before they hatch. But you want to be aware of that with certain things, though, for example, I’m telling some of my clients now, "Well, I don’t want my child to have a loan." I said, "Well, maybe you should have your child take out that loan. Maybe then it’s going to get forgiven. They’re just going off to college for the first year. Maybe that’ll get forgiven."

Because if you get these loans, you actually have up to 120 days to return the funds and you’re not charged any origination fees and there’s no interest. The same with the Parent PLUS Loans. Those might be forgiven or get some benefit there. I’m thinking they may go more with that interest deduction, because it makes sense.

Sandy Block: It’s more palatable, yeah.

Kalman Chany: If they forgive these loans, a lot of people are saying, "I lost to gene lottery. I paid off all my loans. I did this. Why are these people getting a benefit? I’m not."

Sandy Block: And all those people have written to us, yes.

Kalman Chany: And a lot of people, too, the colleges are going, "Look, if they give this to kids, they’ll keep thinking we can just borrow recklessly because eventually it’s going to get forgiven again in the future." So, I don’t-

David Muhlbaum: The old moral hazard.

Sandy Block: The moral hazard. Yeah.

Kalman Chany: Right. So, I don’t know if it’s the polls show that’s popular. But I think a lot of people who paid off these loans or maybe didn’t take out loans and did that, or they struggled to pay off their loans and were eating noodle soup every night or mac and cheese in a box, because they didn’t have much money for food because they were paying off their loans. Those people, I don’t think are going to be very happy to find out that, based on timing, "Someone else had their loan forgiven, but I had to pay." So, I think if they do that, that might be viewed more as fair to help people, because there happen to tax, for example, Senator Warren’s been saying, "The government is charging this money, the interest on all these loans, making this." But part of that had to be done, because to make the Affordable Care Act work, which is actually the Affordable Care and Education Loan Reform Act work. In the first 10 years, they had to get $50 billion out of student aid.

Graduate students, they got rid of interest-free loans while graduate students were in school. They got rid of the private lenders participating in the federal loan programs and all went with direct loans. The private lenders used to then have incentives to get the interest rates down. They’re not there as much as they were before. Like you paid off on time, you could get a reduction of up to 2% off your interest rate. But they don’t have that anymore. So, there’s a large amount of money the government is making on the interest they’re charging on these loans, of course, there’s defaults, too. That has to offset the cost of that. That’s why there are these fees and the interest. But that seems to be a maybe more fair way of doing this, so that people who paid off the loans before won’t be screaming like crazy like, "They gave this here and now I’m paying my taxes so that these kids can get their loans forgiven. What about me?" That may not be so popular come the midterms.

David Muhlbaum: Well, I now think I know who our guest is when we next get to talk about the prospect of-

Sandy Block: Loan forgiveness.

David Muhlbaum: ... student loan forgiveness and, Kal, I had seen from other content, you self-describe yourself as a policy wonk. So, I had that expectation coming in, but still, my mind is blown. But thank you very much for joining us and providing us so much interesting detail. I am not only going to put a link into Publication 970 (opens in new tab), but of course also to how to get yourself a copy of Paying for College, the 2023 edition (opens in new tab), which is coming out September 20th?

Kalman Chany: Right.

David Muhlbaum: So, hang in there.

Kalman Chany: Paying for College, the 2023 edition. That’s what if you don’t have it, you can get it to book sellers or online book sellers. You want to get the 2023 edition.

David Muhlbaum: Right. Which will continue to be updated. So, yeah.

Kalman Chany: For some years, the old edition, they’ve run out of inventory and people have been selling it on the resale market for $1,000, $1,500 a copy for the old edition thinking that there’s not a new one. So, you want to get the updated edition. You can order it now and you’ll get that.

David Muhlbaum: You need to institute dynamic pricing. Well, thank you again for joining us, Kal.

Sandy Block: Thanks, Kal.

David Muhlbaum: That will just about do it for this episode of Your Moneys Worth. If you like what you heard, please sign up for more at Apple Podcasts (opens in new tab) or wherever you get your content. When you do, please give us a rating and a review. If you’ve already subscribed, thanks, please go back and add a rating or review if you haven’t already. To see the links we’ve mentioned in our show, along with other great Kiplinger content on the topics we’ve discussed, go to kiplinger.com/podcast. The episodes, transcripts and links are all in there by date. If you’re still here, because you want to give us a piece of your mind, you can stay connected with us on Twitter, Facebook, Instagram, or by emailing us directly at podcast@kiplinger.com. Thanks for listening.

More on eligibility for American Opportunity, Lifetime Learning Credit

Kalman Chany followed up the recording of this podcast with more detail on claiming certain credits. Where the the money you used to pay for college came from matters, Here is his note:

When we discussed the federal education tax credits (the American Opportunity Credit and the Lifetime Learning Credit), I did not include a statement that funds withdrawn from 529 plans to pay qualified tuition and fees do not count as qualified tuition and fees paid when determining eligibility for those education tax credits. This is because under the IRS tax code one cannot get two federal education tax breaks with the same dollars. So one cannot get: 1) the federal education tax credit and 2) the tax-free treatment of distributions from 529 plans used to pay qualified expenses with the same funds.

In order to qualify for federal education tax credits, one must therefore use funds that have no other tax-advantage to pay the tuition and fees (i.e. one must use regular cash, funds from a checking or savings account, credit card transaction or loan proceeds - and so none of those funds used can be coming directly or indirectly from a 529 plan or Coverall ESA distribution, unless one elects to consider such a distribution as a non-qualifed distribution in which case there would be penalties and a higher tax liability.

This inability to get the two federal tax benefits with the same dollars is the reason why I stated that if one gets all their tuition and fees paid with grants and scholarships (i.e. gift aid) , they would want to weigh the benefits of claiming some of the grants or scholarships as taxable income reported on the student's tax return - especially if there is no tax owed after the standard deduction is claimed. (Such gift aid used to pay tuition and fees as well as required books /supplies has the tax benefit of generally not being required to be reported on a U.S tax return as taxable income as part of the response for Line 1 of the IRS Form 1040 - though the tax filer can opt to report some or all of the gift aid as part of their gross income on the tax return so that that can have qualified tuition and fees payments for the education tax credits.

Sandra Block
Senior Editor, Kiplinger's Personal Finance

Block joined Kiplinger in June 2012 from USA Today, where she was a reporter and personal finance columnist for more than 15 years. Prior to that, she worked for the Akron Beacon-Journal and Dow Jones Newswires. In 1993, she was a Knight-Bagehot fellow in economics and business journalism at the Columbia University Graduate School of Journalism. She has a BA in communications from Bethany College in Bethany, W.Va.