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Taxmap/pubs/p970-033.htm#TXMP40d07e62 Chapter 7 Coverdell Education Savings Account (ESA)

ESA

Introduction

If your modified adjusted gross income (MAGI) is less than $110,000 ($220,000 if filing a joint return), you may be able to establish a Coverdell ESA to finance the qualified education expenses of a designated beneficiary. For most taxpayers, MAGI is the adjusted gross income as figured on their federal income tax return.

There is no limit on the number of separate Coverdell ESAs that can be established for a designated beneficiary. However, total contributions for the beneficiary in any year cannot be more than $2,000, no matter how many accounts have been established. See Contributions, later.

This benefit applies not only to higher education expenses, but also to elementary and secondary education expenses.

Taxmap/pubs/p970-033.htm#TXMP7b0f428e What is the tax benefit of the Coverdell ESA.

Contributions to a Coverdell ESA are not deductible, but amounts deposited in the account grow tax free until distributed.

If, for a year, distributions from an account are not more than a designated beneficiary's qualified education expenses at an eligible educational institution, the beneficiary will not owe tax on the distributions. See Tax-Free Distributions, later.

Table 7-1 summarizes the main features of the Coverdell ESA.

Taxmap/pubs/p970-033.htm#TXMP353e8d1e What Is a Coverdell ESA

Coverdell ESA

A Coverdell ESA is a trust or custodial account created or organized in the United States only for the purpose of paying the qualified education expenses of the designated beneficiary of the account.

When the account is established, the designated beneficiary must be under age 18 or a special needs beneficiary.

To be treated as a Coverdell ESA, the account must be designated as a Coverdell ESA when it is created.

The document creating and governing the account must be in writing and must satisfy the following requirements.

1. The trustee or custodian must be a bank or an entity approved by the IRS.
2. The document must provide that the trustee or custodian can only accept a contribution that meets all of the following conditions.
   1. Is in cash.
   2. Is made before the beneficiary reaches age 18, unless the beneficiary is a special needs beneficiary.
   3. Would not result in total contributions for the year (not including rollover contributions) being more than $2,000.
3. Money in the account cannot be invested in life insurance contracts.
4. Money in the account cannot be combined with other property except in a common trust fund or common investment fund.
5. The balance in the account generally must be distributed within 30 days after the earlier of the following events.
   1. The beneficiary reaches age 30, unless the beneficiary is a special needs beneficiary.
   2. The beneficiary's death.

As of this printing, regulations defining a "special needs beneficiary" have not been released. If available, the definition will be included in Publication 553, Highlights of 2004 Tax Changes, which will be issued in early 2005.

Table 7-1.

Coverdell ESA at a Glance

Do not rely on this table alone. It provides only general highlights. See the text for definitions of terms in bold type and for more complete explanations.

Question	Answer
What is a Coverdell ESA?	A savings account that is set up to pay the qualified education expenses of a designated beneficiary.
Where can it be established?	It can be opened in the United States at any bank or other IRS-approved entity that offers Coverdell ESAs.
Who can have a Coverdell ESA?	Any beneficiary who is under age 18 or is a special needs beneficiary.
Who can contribute to a Coverdell ESA?	Generally, any individual (including the beneficiary) whose modified adjusted gross income for the year is less than $110,000 ($220,000 in the case of a joint return).
Are distributions tax free?	Yes, if the distributions are not more than the beneficiary's adjusted qualified education expenses for the year.

Taxmap/pubs/p970-033.htm#TXMP04345502 Qualified Education Expenses

Qualified Education Expenses

Generally, these are expenses required for the enrollment or attendance of the designated beneficiary at an eligible educational institution. For purposes of Coverdell ESAs, the expenses can be either qualified higher education expenses or qualified elementary and secondary education expenses.

Taxmap/pubs/p970-033.htm#TXMP65e7f49c Designated beneficiary.

This is the individual named in the document creating the trust or custodial account to receive the benefit of the funds in the account.

Taxmap/pubs/p970-033.htm#TXMP2b8f065e Eligible Educational Institution

For purposes of Coverdell ESAs, an eligible educational institution can be either an eligible postsecondary school or an eligible elementary or secondary school.

Taxmap/pubs/p970-033.htm#TXMP335893bb Eligible postsecondary school.

This is any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the Department of Education. It includes virtually all accredited, public, nonprofit, and proprietary (privately owned profit-making) postsecondary institutions. The educational institution should be able to tell you if it is an eligible educational institution.

Certain educational institutions located outside the United States also participate in the U.S. Department of Education's Federal Student Aid (FSA) programs. You can find a list of these foreign schools on the Department of Education's website at www.fafsa.ed.gov/index.htm. Click on "Find my school codes." Complete the two items on the first page and click "Next." Follow the instructions to search for a foreign school.

Taxmap/pubs/p970-033.htm#TXMP1125c941 Eligible elementary or secondary school.

This is any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law.

Taxmap/pubs/p970-033.htm#TXMP7c937dcc Qualified Higher Education Expenses

Qualified Higher Education Expenses

These are expenses related to enrollment or attendance at an eligible postsecondary school. As shown in the following list, to be qualified, some of the expenses must be required by the school and some must be incurred by students who are enrolled at least half-time. Contributions to qualified tuition programs can be qualified education expenses (see item (4) in the following list).

1. The following expenses must be required for enrollment or attendance of a designated beneficiary at an eligible postsecondary school.
   1. Tuition and fees.
   2. Books, supplies, and equipment.
2. Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible postsecondary school. (See Caution in the next column.)
3. Expenses for room and board must be incurred by students who are enrolled at least half-time (defined in the next column).The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts.
   1. The allowance for room and board, as determined by the school, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
   2. The actual amount charged if the student is residing in housing owned or operated by the school.
   
   
4. Any contribution to a qualified tuition program (QTP) must be on behalf of the designated beneficiary of the Coverdell ESA. (See chapter 8, Qualified Tuition Program (QTP).)

Taxmap/pubs/p970-033.htm#TXMP18d45bfb Half-time student.

A student is enrolled "at least half-time" if he or she is enrolled for at least half the full-time academic work load for the course of study the student is pursuing, as determined under the standards of the school where the student is enrolled.

Taxmap/pubs/p970-033.htm#TXMP7fc4fcf9 Qualified Elementary and   Secondary Education Expenses

Qualified Elementary and Secondary Education Expenses

These are expenses related to enrollment or attendance at an eligible elementary or secondary school. As shown in the following list, to be qualified, some of the expenses must be required or provided by the school. There are special rules for computer-related expenses.

1. The following expenses must be incurred by a designated beneficiary in connection with enrollment or attendance at an eligible elementary or secondary school.
   1. Tuition and fees.
   2. Books, supplies, and equipment.
   3. Academic tutoring.
   4. Special needs services for a special needs beneficiary. (See Caution below.)
2. The following expenses must be required or provided by an eligible elementary or secondary school in connection with attendance or enrollment at the school.
   1. Room and board.
   2. Uniforms.
   3. Transportation.
   4. Supplementary items and services (including extended day programs).
3. The purchase of computer technology, equipment, or Internet access and related services is a qualified elementary and secondary education expense if it is to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is in elementary or secondary school. (This does not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature.)

As of this printing, regulations defining a "special needs beneficiary" have not been released. If available, the definition will be included in Publication 553, Highlights of 2004 Tax Changes, which will be issued in early 2005.

Previous Page:  Publication 970 - Tax Benefits for Education - When Must the Deduction Be Repaid (Recaptured) Next Page:  Publication 970 - Tax Benefits for Education - Contributions Use     to find additional instances of index items.