5 Ways the New Tax Law Affects Paying for College

The final version of the GOP tax bill that passed last month rewrites the tax code in many ways, eliminating deductions and adding new benefits. Some of these new provisions affect those paying for college.

After public outcry on several provisions proposed in the House's tax bill, the Senate version that passed last month left many tax credits related to higher education untouched.

The new tax bill keeps the deduction for student loan interest. Additionally, the tuition waivers that graduate students receive will stay tax free, and other tax credits – such as the Lifetime Learning Credit and the American Opportunity Tax Credit – remain unscathed.

"A lot of things didn’t change that we were worried about changing – the taxation of the tuition waiver, the taxation of employer tuition assistance. We worried about that happening, but it didn’t end up happening," says Shannon Vasconcelos, director of college finance at College Coach, an admissions consulting firm.

But a few key changes will affect families and students who are financing higher education. Here are five new tax codes that may change a family's finances.

1. Deductions for interest on home equity loans and lines of credit are eliminated. Under the new tax legislation, the ability to deduct interest on home equity loans is suspended from 2018 to 2025.

"This one is a real big one that is a bummer for families," says Vasconcelos. "For a lot of families, it's the best interest rate – it's better than a lot of the education loan rates. A lot of families do tap their home equity to pay for college, so losing the deduction is going to cost them fairly significant money."

The new restrictive mortgage rules that cap interest on new loans to $750,000 will also "prevent many middle-income taxpayers from using home-equity loans in the future to fund college tuition, while generating tax-deductible interest," says Blake Christian, a CPA at Holthouse, Carlin, Van Trigt, a Southern California accounting firm.

2. Families can use 529 plans to pay for K-12 education. Families can now use qualified education expenses in a tax-advantaged 529 savings account to pay for elementary or secondary school tuition. The new tax code allows taxpayers to pay up to $10,000 per student per year in K-12 tuition.

But college experts caution some families against using this new flexibility with 529 accounts. Sean Moore, founder of SMART College Funding, worries that parents who redirect these funds to cover private school education may use the money too quickly and come up short for college.

Christian from HCVT says this benefit will largely help families with a high net worth.

3. Colleges and universities will pay a new excise tax on endowments. A new excise tax levies a 1.4 percent on a private educational institution's endowments that amount to more than $500,000 per student.

The new provision affects scores of private universities with large endowments, such as Harvard University in Massachusetts, the University of Notre Dame in Indiana and Stanford University in California, to name a few.

"It's going to cost these colleges money. How much is going to be passed on to students and parents – we don't know yet. The colleges are just now figuring out how to deal with this new tax," says Vasconcelos from College Coach.

4. Student loans discharged for death or disability are now tax-exempt. The new tax code makes death and disability discharges of federal and private education loans tax-free.

Previously, the debt cancellation would be added as income on to the taxpayer's bill. Now the cancellation of the student debt is tax-free. But the new tax code only applies to discharges that occur during 2018 to 2025.

"It's great for those families who suffer from those devastating effects. But the reality is the people that it helps are hopefully very small," says Moore from SMART College Funding.

5. Alimony for recipients is no longer taxable. College consulting experts say this provision should make it easier for custodial parents to qualify for need-based aid when filling out the Free Application for Federal Student Aid, commonly known as the FAFSA. For the most part, the FAFSA for college-bound students relies on parental information, such as tax records.

"Without alimony showing up on their tax returns, divorced custodial parents should be eligible for financial aid," says Joe Orsolini, president of College Aid Planners, a consulting organization in Illinois that helps families navigate paying for college. "This change will make is easier for them to qualify."

Even with this provision, the FAFSA uses tax records from the prior prior year – so there is a time gap to when this new tax code would benefit a custodial parent. But Orsolini says this should benefit these parents "unless the Department of Education catches on to this and changes the FAFSA."

Source: https://www.usnews.com/education

When an HSA-First Strategy Makes Sense

Many--perhaps most--articles about health savings accounts suggest that employees with an HSA who participate in a 401(k) plan should first contribute to the 401(k) plan the percentage of their compensation that enables them to obtain the maximum plan sponsor match, such as 3% on the employee's first 6% of compensation. Employees should then max out their HSA account contributions through payroll deductions. Once that's done, they should go back to contributing any additional dollars to their 401(k) plans.

While this strategy is indeed attractive, an even better one would be to change the sequence of the contributions. That is, employees should first max out contributions to their HSAs no matter their tax bracket, and once that's done, contribute to their 401(k) plans.

Break out that trusty old HP 12C and calculate any contribution, time horizon, and interest-rate combination. Then reduce that number by, say, 25% for tax to come up with the 401(k) balance. (An HSA demonstrates even greater superiority over an employer match in a 401(k) plan when withdrawals are made at a tax bracket higher than 28%, thereby illustrating the power of tax-free withdrawals in retirement. That is, the higher an employee's tax bracket, the larger the employer's 401(k) match must be to in order beat contributing to an HSA first.) 

A 401(k) plan will beat an HSA if left to retirement. However, reality intrudes when withdrawals are made from the 401(k) to pay for things like medical expenses and a participant in a 401(k) is slammed with taxes and penalties. This is why it makes the most sense to first max out HSA contributions and thereafter get the maximum company match from the 401(k).

Do the same for an HSA but then factor in a 7.65% (FICA) discount up-front and no tax deduction at the back end. In most calculations, the HSA-first strategy is ahead by one third. Then, add in a typical employer match of 3% on the first 6% in employee compensation and take the balance out at a 35% tax bracket. The result: HSA tax savings even beat the employer's match. And don't forget, 80% of employers that offer an HSA contribute $500-1,500 to an employee's HSA.

Once these two no-brainers are accomplished--max out HSA contributions first and then obtain a full company match for the 401(k) plan--only at that point should employees begin their retirement needs planning for the year and so on into the future.

For those who are uncomfortable with this strategy for whatever reason, perhaps they would prefer contributing simultaneously to both the HSA and the 401(k) account on a regular periodic basis throughout the year.

Apart from the issue of the sequence of contributions to an HSA and a 401(k) plan is the issue of the difference in the amount of contributions. For example, Employee A saves and invests $5,000 (a nice round number used even though it slightly exceeds what an individual 55 or older can currently contribute annually to an HSA) annually for 30 years in an HSA. Employee B also saves and invests $5,000 annually for 30 years in a 401(k) account. Employee A in the HSA will amass $611,729 while Employee B in the 401(k) plan will amass $423,699.

The differential in favor of the HSA of nearly $200,000 is due to avoiding payment of the (up-front) 7.65% FICA tax (or more in certain other states and localities) for 30 years of contributions. (Assumptions for the foregoing terminal amounts include a 25% income tax bracket, an 8% return, an HSA that's in the payroll deduction scenario to avoid paying 7.65% in FICA taxes and HSA assets are used for qualified medical expenses. Also, a 25% income tax bracket was applied for withdrawal of 401(k) money.)

Tax-Deferred Accumulation of Earnings and Interest on Contributions
Any earnings and interest generated on contributions to an HSA accumulate tax-deferred over time. When these accumulations are used to pay for qualified medical expenses or to reimburse an HSA holder for previous qualified medical expenses, they become tax-free distributions.

Tax-Free Distributions to Pay for Qualified Medical Expenses
In essence, HSA assets can be used to pay for anything tax-free. Suppose that HSA holders are able to max out contributions to their HSAs and pay for qualified medical expenses out-of-pocket through some or all of their careers. If the holders have kept their medical expense receipts over time, they can get reimbursed later for those expenses from their HSAs.

There's not even a need to have a current qualified medical expense; the HSA holder merely needs to have a receipt from any time in the past to get reimbursed. Qualified medical expenses, then, can arise from any year--not just the current one. This proactive strategy allows an HSA holder to augment retirement income tax-free rather than first pulling money from, say, its taxable 401(k) plan account. This could be helpful in cases where withdrawals from a 401(k) account could bump the holder into a higher tax bracket which could also result in higher Medicare premiums

Other instances of the versatility and flexibility of the HSA abound. For example, the fact that an HSA holder can contribute to an HSA until April 15 for the previous tax year (like an IRA) allows for a post-calendar year tax avoidance strategy. Suppose that a 56-year old self-employed worker had $4,000 in medical expenses and paid for them with (after-tax) out-of-pocket money because the worker didn't know that he or she was eligible for an HSA. A savvy investment advisor informed the worker about eligibility.

So before tax-time in April, the worker establishes an HSA and contributes $4,000, thereby avoiding payment of federal and state income taxes. (But not FICA taxes because the self-employed cannot establish an IRS section 125 cafeteria plan. However, LLC or LLP members might be able to establish a 125 plan if they have elected to be taxed as a Subchapter C Corporation; competent professional counsel should be consulted in such cases.) The worker then took out $4,000 from his or her HSA to reimburse himself/herself.

The result: a wash that saves a lot in taxes. This post-calendar year tax avoidance strategy demonstrates again that having a receipt for qualified medical expenses that were paid even far in the past allows an HSA holder to get reimbursed--assuming, of course, that the holder has been able to pay for its medical expenses out-of-pocket along the way.

Additional Advantages of HSAs
The Tax Cuts and Jobs Act passed by Congress last year failed to further expand the advantages of HSAs. However, it's thought that there will be a Medicaid/Medicare HSA provision as well as one to increase HSA contribution limits included in the 2018 Budget Reconciliation Act. In the meantime, here are some additional advantages of an HSA.

Full Vesting. Any contributions made to an employee's HSA by either the employee or its employer are immediately vested in the employee.

Portability. An HSA can be opened by a worker anywhere. For example, if employees don't like their employer-sponsored HSAs, say, because it's pricey and/or the investments are suboptimal (which is often the case), they can pull the assets from it and invest them elsewhere in an optimal HSA (within 60 days but without the rigmarole of a rollover). The downside to this non-payroll deduction scenario, of course, is that employees cannot take the 7.65% (or more) deduction for FICA taxes. Even if employees are currently ineligible to make contributions to their HSAs, the HSA always stays with them not their employers.

Flexibility. HSA holders can withdraw HSA assets or change them at any time while letting the HSA accounts accumulate, regardless of their current employer or current eligibility. In addition, there are no required minimum distribution rules or requirements to begin taking withdrawals at a certain age.

Sources of Contributions. Those other than HSA holders can contribute to a holder's HSA including a family member and, as noted, their employers.

Coverage for Family. HSA holders can use assets from their own HSAs to pay for qualified medical expenses incurred by spouses and their tax dependents even if they aren't eligible to establish their own HSAs or even if they have health insurance different than the holder.

At Death. At an employee's death, the HSA can be rolled over to a spouse tax-free, plus that spouse can continue to save and invest in the HSA. But if the HSA is rolled over to a nonspouse, the HSA balance is fully taxable like the balance in a 401(k) plan.

Medicare/Retirement. The Medicare Part B monthly premium (for visits to the doctor) is deducted from a recipient's monthly Social Security check. In such cases, however, an HSA holder can get reimbursed from HSA assets for these premiums as well as Part D monthly premiums (for drug prescriptions).

Source: http://news.morningstar.com/articlenet/article.aspx?id=842764

Contractors could benefit from new tax law

The new tax law is likely to accelerate a hotly disputed trend in the American economy by rewarding workers who sever formal relationships with their employers and become contractors.

Management consultants may soon strike out on their own, and stockbrokers may hang out their own shingle.

More cable repairmen and delivery drivers, some of whom find work through gig economy apps like Uber, may also be lured into contracting arrangements.

That’s because a provision in the tax law allows sole proprietors — along with owners of partnerships or other so-called pass-through entities — to deduct 20 percent of their revenue from their taxable income.

The tax savings, which could be around $15,000 per year for many affluent couples, may prove enticing to workers. “If you’re above the median but not at the very, very top, one would think you’d be thinking it through,” said David Kamin, a professor of tax law at New York University.

The provision may also turn out to be a boon for employers who are trying to reduce their payroll costs. Workers hired as contractors, who tend to be cheaper, may be less likely to complain about their status under the new tax law.

“Firms currently have a lot of incentives to turn workers into independent contractors,” said Lawrence Katz, a labor economist at Harvard. “This reinforces the current trends.”

But it could lead to an erosion of the protections that have long been a cornerstone of full-time work.

Formal employment, after all, provides more than just income. Unlike independent contractors, employees have access to unemployment insurance if they lose their jobs and workers’ compensation if they are injured at work. They are protected by workplace anti-discrimination laws and have a federally backed right to form a union.

Those protections do not generally apply to contractors. Nor do minimum-wage and overtime laws.

“What you’re losing is the safety nets for those workers,” said Catherine Ruckelshaus of the National Employment Law Project, an advocacy group.

Traditional full-time jobs also insulate workers against the peaks and troughs in the demand for their services. Consider, for instance, the erratic income of retail or fulfillment-center workers hired in the fall and let go after the holidays.

And because companies have internal pay scales, the lowest-paid employees tend to make more than they would on the open market.

“It used to be that companies like G.M. or the local bank or factory directly employed the janitor, the clerical worker,” Professor Katz said, noting that their pay would rise along with other employees’ when the company was doing well.

Unwinding employment relationships eliminates these benefits, increasing the volatility of workers’ incomes and magnifying pay disparities and inequality.

It’s difficult to say how many workers would choose to become contractors as a result of the new provision, which for couples frequently begins to phase out at a taxable income above $315,000. Mr. Kamin said joint filers who make close to $315,000 and could transform most of these earnings into business income would find it most compelling to make the change. (It could be more compelling still if one spouse’s employer offered the couple health insurance, which many employers provide even though they aren’t required to.)

On the other hand, many individuals fail to avail themselves of existing tax deductions, like the one that freelancers can take for their expenses, said Jamil Poonja of Stride Health, which helps self-employed workers buy health insurance. That may reflect the lack of access among lower-earning workers to sophisticated tax advice.

The tax benefit could also be offset in some cases by the need for contractors to pay both the employer and employee portion of the federal payroll tax.

Many employers are already pushing the boundaries of who they treat as employees and who they treat as independent contractors.

In theory, it is the nature of the job, and not the employer’s whim, that is supposed to determine the worker’s job status.

If a company exerts sufficient control over workers by setting their schedules or how much they charge customers, and if workers largely depend on the company for their livelihood, the law typically considers those workers to be employees.

True contractors are supposed to retain control over most aspects of their job and can typically generate income through entrepreneurial skill, and not just by working longer hours.

In practice, however, many companies classify workers who are clearly employees as contractors, because they are usually much cheaper to use. And many labor advocates say the new tax deduction will encourage more employers to go that route by giving them an additional carrot to dangle in front of workers.

“The risk presented by this provision is that employers can go to workers and say, ‘You know what, your taxes will go down, let me classify you as an independent contractor,’” said Seth Harris, a deputy labor secretary under President Barack Obama.

Anything that makes workers more likely to accept such an arrangement makes it harder to root out violations of the law. That is because the agencies responsible for policing misclassification — the Labor Department, the Internal Revenue Service, state labor and tax authorities — lack the resources to identify more than a fraction of the violations on their own.

“Your chances of finding a worker that’s been misclassified if that worker has not complained are worse than your chances of finding a leprechaun riding a unicorn,” Mr. Harris said.

David Weil, the administrator of the Labor Department’s Wage and Hour Division under Mr. Obama, believes the change will add fuel to a trend that has been several decades in the making.

During that time, as Mr. Weil documented in a book on the subject, “The Fissured Workplace,” employers have steadily pushed more work outside their organizations, paring the number of people they employ and engaging a rising number of contractors, temporary workers and freelancers.

The tax law will accelerate the shift, he said, because employers who are already keen to reorganize in this way will recognize that even fewer workers are likely to object as a result of the tax benefits.

The effect of the deduction could be especially big in industries where misclassification is already rampant.

Many small-time construction contractors hire full-time workers who should be classified as employees but are kept on as freelancers or paid under the table, said Kyle Makarios, political director for the United Brotherhood of Carpenters and Joiners of America.

Mr. Makarios said the pass-through provision would encourage even more building contractors to misclassify workers, allowing them to reduce their labor costs and underbid contractors who play by the rules.

The practice by ride-hailing companies like Uber and Lyft of classifying drivers as independent contractors has long been criticized by labor advocates and plaintiffs’ lawyers. They argue that the companies control crucial features of the working relationship and hold most of the economic power.

Neil Bradley, senior vice president and chief policy officer at the U.S. Chamber of Commerce, said that gig-economy companies classify workers as contractors when it suits the needs of their business and that he did not expect that to change. He also said he did not expect firms with traditional business models to follow suit as a result of the new provision.

“I think the decision is going to be driven by the considerations” that lawyers cite, such as the amount of control a company exercises, he said, “not by this tax bill.”

But Mr. Weil was less sanguine.

“These kinds of approaches to making it easier to slide into independent contractor status reflect unequal bargaining power,” he said. “When you add to that an additional financial incentive, you’re just unwinding the whole system.”

Source: https://www.nytimes.com/2017/12/31/business/economy/tax-work.html?WT.mc_id=SmartBriefs-Newsletter&WT.mc_ev=click&ad-keywords=smartbriefsnl