Educate yourself on avoiding taxes

Kids heading off to college or university can be a big transition for both parents and children. Let’s not forget that it is also a time to be practical. As I reminded my neighbours as they helped their son pack for his first year of university, all those receipts for moving expenses should be held onto. They will come in handy at tax time. I shared those and other tips with them to help them minimize the cost of their son’s higher education.

Taxes won’t be the first thing on your clients’ minds as they send their children off to school, but you will be doing them a favour if you raise the subject. While the kids are getting an education, you’ll be educating parents in ways they can all save. Trust me — they’ll thank you later.

Students derive their income from the salaries, tips and other occasional earnings they get from various jobs. Some have investment income as well. For the purposes of this article, however, I’m going to focus on the types of advice you can give clients about sources of income and deductions that are unique to education — the proceeds of bursaries, fellowships, grants and scholarships, withdrawals from different types of tax-sheltered savings plans and other types of non-refundable tax credits.

Scholarships, fellowships, bursaries, and study grants

If students are in programs that allow them to claim the education tax credit, the full amounts of any scholarships, fellowships or bursaries they receive will not be taxable and won’t be reported as income on their tax returns. Even if students are not eligible for the education tax credit, the first $500 of the scholarships, fellowships or bursaries they receive will be tax free. The excess will be included in taxable income.

Registered education savings plans (RESPs)

There are two types of withdrawals from RESPs. A capital withdrawal isn’t subject to tax, which makes sense because there was no deduction from taxable income when the contribution was made in the first place. However, an “education assistance payment” or EAP withdrawal, which represents accumulated earnings and grants on previous contributions, is taxable. An EAP withdrawal, which requires proof of enrolment at a qualifying institution, will be reported as other income on a student’s T4A slip. Since students typically don’t earn very much, chances are they will pay little or no tax. At the very least, the rate will be less than the plan contributors — their parents — would have to pay. Residents of Quebec and Alberta should also consider taking advantage of the Quebec Educational Savings Incentive (QESI) and Alberta Centennial Education Savings Plan (ACES), respectively. Both provincial grants are treated like an EAP withdrawal for tax purposes, and a variety of financial institutions are currently upgrading their systems to administer these grants.

RRSP education withdrawals (Lifelong Learning Plan)

Under the Lifelong Learning Plan (LLP) provision, a student is allowed tax-free withdrawals of funds from an RRSP (or a spousal or common-law partner’s RRSP) to finance training or education programs. Students can withdraw up to $10,000 a year, to a maximum of $20,000 over a four-year period for educational programs offered by a designated educational institution (university or college). Qualifying programs must last three consecutive months or more, and students must spend 10 hours or more per week on course or related work. Withdrawals have to be repaid over a 10-year period.

In fairness, few young students will have enough in their RRSPs to make this option viable. More often, you’d be advising a more mature client — say, someone like my neighbour Sarah, who is in an executive MBA program — to take advantage of this opportunity.

Using common deductions to save on taxes

Students who move at least 40 kilometres to attend a post-secondary school full-time can deduct moving expenses from taxable scholarship or award income they receive during the school year or from part-time jobs they hold while going to school. Such expenses can be claimed at the beginning and end of academic years and can be claimed even if a student moves to a new location for work rather than returning home. The greatest benefit of this deduction is realized the year a student finishes school and can deduct moving costs against employment income from a new job.

Students with children get a break too. If a student/parent spends at least 12 hours a month studying in a program that lasts at least three consecutive weeks, child care expenses can be deducted from income.

Ins and outs of non-refundable tax credits

Various non-refundable tax credits can reduce a student’s tax with the stipulation that if the combined total of credits exceeds tax payable, there will be no refund for the difference. The most common of these credits are the Canada Employment Credit, the transit pass credit, student loan interest credit and credits for education (in different amounts based on part- or full-time attendance), tuition fees and textbook costs. Generally, the rules for claiming federal, provincial and territorial non-refundable tax credits are the same, although the value and the calculation of most provincial and territorial rules are different from their federal equivalents.

Here’s how the principal non-refundable credits can work for students:

Canada employment amount

This is a federal non-refundable tax credit on the first $1,000 of earned employment income (indexed annually for inflation). It’s based on the lesser of $1,000 and the total employment income reported on the student’s tax return. In 2009, the amount with indexation is $1,044. Of the provinces and territories, only Yukon provides a non-refundable tax credit for the Canada employment amount.

Public transit amount

Students can claim the cost of public transit passes for periods of a month or more as a non-refundable tax credit. Such passes must apply to unlimited travel on local buses, streetcars, subways, commuter trains or buses and local ferries. It isn’t necessary to file receipts and passes with a tax return, but they should be kept in case Revenue Canada asks for them at a future date.

Interest paid on student loans

Students who receive federally or provincially approved loans for post-secondary education can claim a tax credit for a portion of the interest payable. To get the credit, students have to consolidate their student loans with an authorized lender following graduation and assume responsibility for paying interest by the first day of the seventh month following completion of their studies. The credit is non-transferable and can be used for up to five taxation years.

The key is to use this tax credit effectively. If a student has no tax payable in an initial year in which interest is paid, there is no value in claiming the tax credit. It’s better to carry it forward to years when it can be applied to reduce taxable income.

It’s important to remember that students cannot claim interest paid on any other kind of loan or on a student loan that has been combined with another kind of loan. For example, if a person renegotiates a student loan with a bank or another financial institution, or includes it in an arrangement to consolidate several loans, the interest on the new loan will not qualify for this tax credit.

Tuition, education and textbook amounts

Students can claim the education amount tax credit for all or part of each month in which they are enrolled in qualifying programs at designated educational institutions. Educational institutions provide official tax receipts (a T2202 Education and Textbook Amounts Certificate or a T2202A Tuition, Education and Textbook Amounts Certificate) showing the number of months students were enrolled. The federal claim amount is $400 per month for full-time enrolment and $120 per month for part-time enrollment. Students who take qualifying educational programs in connection with their employment can claim the education tax credit provided that none of the cost is reimbursed by the employer.

The T2202A, Tuition, Education and Textbook Amounts Certificate, is issued to those claiming the tuition credit for amounts greater than $100 paid to a particular institution in a given year. Lesser amounts cannot be claimed. The same certificate is issued to those claiming the textbooks tax credit. This additional federal non-refundable tax credit allows a claim of $65 per month for full-time attendance and $20 per month for part-time attendance.

There are a few caveats, however. Tuition fees paid by a student’s or parent’s employer will not be deductible unless the reimbursed amount is included in the student’s or parent’s income. As well, books other than textbooks cannot be claimed, nor can room and board and student association fees.

Time and flexibility are on a student’s side

Students who don’t have sufficient income to utilize their total claims for the education, tuition and textbook amounts can carry them forward indefinitely. Additionally, they can transfer these claims to spouses or common-law partners, to their own parents or grandparents or even to parents and grandparents of spouses or common-law partners. In the case of parents and grandparents, however, there is an annual maximum that can be transferred.

What you must remember about transferring claims is that the amounts transferred should not exceed the costs a student could use on a given year’s tax return. Any excess could then be carried forward. In that case, however, those unused costs cannot be transferred to someone else in a future year.

These are just the major student tax issues that you should bring up with clients. Think of yourself as an educator, teaching the course Tax Savings 101.