Some tax benefits for college costs expire at end of 2010

Some parents have big dreams about what they'll do when their children start college. They'll take a cruise, go back to school, maybe walk around the house with no clothes on. But unless your child has received a generous scholarship, mooning your neighbors may be all that you can afford to do.

You can take some of the sting out of college bills by taking advantage of the credits, deductions and other tax-advantaged programs Congress has enacted to make college more affordable. At the end of this year, though, some of those benefits are scheduled to expire. Here's a look at what's changing:

Tax credit

The American Opportunity Credit, included in last year's economic stimulus package, provides a tax credit of up to $2,500 per student in 2010. You can claim the credit for up to 100% of the first $2,000 in qualified college costs and 25% of the next $2,000. To get the full credit, you'll need to spend at least $4,000 on qualified expenses.

Forty percent of the credit is refundable, so a low-income family that doesn't owe federal taxes could receive a check from the government for up to $1,000.

In addition, the income limits on this credit are broader than limits on the Hope and Lifetime Learning Credits, which have been around since the Clinton administration. Married couples with modified adjusted gross income of up to $160,000 can claim the full credit.

The credit is scheduled to expire on Dec. 31. There's a good chance Congress will extend it, "but the question is when," says Mel Schwarz, partner at Grant Thornton in Washington, D.C. One possibility is that Congress will wait until next year to extend the tax credit and make it retroactive for 2011.

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In any event, it makes sense to get the most out of the credit available for 2010. If you haven't already run up $4,000 in qualified expenses, here are some steps you can take before the end of the year:

•Prepay tuition. Many colleges send out tuition bills for the spring semester at the end of the year. If you pay the bill before Dec. 31, you can claim the credit for those expenses on your 2010 tax return, says Melissa Labant, tax technical manager for the American Institute of Certified Public Accountants.

•Buy next semester's textbooks. Textbooks and course materials are qualified expenses for the American Opportunity Credit. If your child knows what courses he or she is going to take in the spring, you can buy textbooks before Dec. 31 and claim the credit, says Gil Charney, tax researcher for H&R Block's Tax Institute.

You can't claim the credit for expenses paid with your 529 college savings plan, says John W. Roth, tax analyst for CCH, a publisher of tax reference books. Because 529 plans also receive special tax treatment — withdrawals are tax-free if they're used for educational purposes — that's considered double-dipping. Instead, use your 529 plan to pay for costs that aren't covered by the tax credit, such as room and board.

Coverdell accounts

Since 2002, Coverdell Education Savings Accounts have allowed families to save up to $2,000 a year in a portfolio of mutual funds or other investments. Contributions are after-tax, but withdrawals are tax-free as long as the money is used for qualified expenses. Along with college-related costs, the money can be used for tuition at a primary or secondary school.

Barring action by Congress, though, these accounts will become much less appealing after Dec. 31. Annual contributions will shrink to $500, and tuition for primary and secondary schools will no longer be a qualified expense, says Barbara Weltman, author of J.K. Lasser's 1001 Deductions and Tax Breaks. Even more significantly, a portion of withdrawals taken after Dec. 31 will be taxed, Weltman says. What to do before year's end if you have a Coverdell account:

•Roll it into a 529 college savings plan. As long as you roll the money directly into a 529 plan, you won't have to pay taxes on it. Withdrawals from 529 plans are tax-free as long as the money is used for qualified expenses.

•Spend the money. Under current law, you can use Coverdell funds to pay for a broad range of education expenses, including computers, school uniforms and tutoring. If you've got some money sitting around in a Coverdell account, "use it up," Weltman says. "That way, it's all going to be tax-free."