When to deduct the costs of earning a master's degree

Q: I'm thinking about going back to school to get a master's degree, but I'll still have income from part-time work and investments. Is there any way I can deduct my tuition or other education-related expenses from my taxes?
J.A., Lexington, Mass.

A: Normally you cannot deduct tuition or education-related expenses for a master's degree unless it is required by your employer and undertaken to improve your work performance, according to an information officer for the IRS in Washington.

Still, you may be able to qualify for a "lifetime learning credit" of up to $1,000 per year, he says.

To learn more, see IRS Publication 17, chapter 36, as well as Publication 970. If you do qualify for the credit, you will need to submit form 8863, which has an accompanying worksheet.

Q: Our kids were given stock from a dividend reinvestment plan (DRIP) in one company from my folks to help pay for college. I was told the tax was already paid on it and that we did not have to pay taxes on it again, even after we take it out to pay education-related expenses. Each year, interest and dividends are reported on a 1099 form provided by the brokerage firm we use. Do we have to pay taxes related to this DRIP?
J.M., Bethesda, Md.

A: Since the stock was turned over to the children by the grandparents, you as parents should be in the clear in terms of taxes. The children would have to list any dividends produced by the stock on their tax forms, even if the dividends were used for college-education purposes, according to an IRS spokesman.

But whether the children actually pay a tax on the dividends will be determined by their annual earnings, the spokesman says.

Had the grandparents paid the college directly, using the dividends, there would have been no potential taxable event for the children, since there is an unlimited gift-tax exclusion on direct gifts for college tuition.

For further details, call the IRS at 800-829-1040.

Q: I am a widower with no heirs and expect to receive retirement benefits in a couple of years. The money I have already put away in a mutual fund (mostly in regular and Roth IRAs) is now worth $115,000. I'm told that if I keep that investment it will eventually rise in value. I'm also told that it is wise to diversify, and that I might consider bonds when they come down. I now hold an additional $100,000 in a low-interest-bearing money-market savings account. How do I make the most of it? I prefer not to invest in alcohol, pharmaceuticals, tobacco, or biogenetics.
Tom, via e-mail

A: "You raise two account issues here," says Tim Shmidl, a financial planner with Prism Group in Overland Park, Kan.

"First, regarding the $115,000, leave the account in place, since it appears that the stock market is coming back, so your total asset value should rebound somewhat."

So far as the low-interest-earning $100,000 money-market account, "keep some of those assets in the money fund for short-term emergency purposes," says Mr. Shmidl.

The amount should fit your needs, such as setting aside three to six months' worth of expenses.

"But you also may want to invest some of the remaining money in a balanced mutual fund, which will give you both stock and bond market exposure," Shmidl says. "Buying pure bond funds now could be risky. If interest rates go up, then bond prices will fall. But a balanced fund, or a conservative short-term bond fund might give you a better return than the money-fund rate."

A number of fund firms – such as Domini, Pax World, and Calvert – use social-investing screens. Shmidl also likes Washington Mutual Investors. The screen isn't as tight, he says, "but returns are quite good, and the company is excellent."

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