CRS Reviews Tax Credits for Personal Development Accounts

There are three current forms of IDA programs, all of which are funded by federal, state, or local governments.¹ Based on the funding mechanism and statutory authority for the program, the three types of programs are as follows.

Temporary Aid to Needy Families Programs. The 1996 welfare reform law (P.L. 104-193) allowed states to use funds from the Temporary Aid to Needy Families (TANF) block grant for IDAs for TANF-eligible persons. States may establish IDA programs and match funds deposited by IDA participants. States may also pay administrative costs for the IDA program in addition to, or in lieu of, matching IDA deposits.

Federal Demonstration Programs. The Assets for Independence Act (AIA, Title IV of P.L. 105-285) authorized a five- year demonstration program, begun in 1999, for IDAs. Federal funds are provided directly to non-profit community groups, state and local governments, or certain financial institutions to establish IDA programs. Federal funds are used to match contributions made by program participants. Program sponsors that match contributions by program participants as part of the demonstration program, must have secured funding for all of the match before receiving federal funds.

Refugee Programs. The Office of Refugee Resettlement (ORR) uses agency funds to establish and maintain IDA accounts for refugees, including a match of contributions by program participants.

For each of these forms of IDA programs, government funds are used to match participant contributions. For state programs associated with TANF, states may use part of the federal TANF block grant, for the federal demonstration program discretionary federal funds are used, and for the refugee program federal agency funds are used. For some state programs associated with TANF, the state may also provide state tax credits for contributors to the program.

For an IDA account established under the federal demonstration program, there may be two components: (1) a main account for the participant's deposits and earnings on those deposits; and (2) a parallel account maintained by the program's financial partner containing the matching contributions and earnings on the matching contributions. Unlike the main account, the parallel account is not controlled by the program participant, but by the IDA program and its financial partner.

Under current federal law for IDA accounts established under the federal demonstration program, the parallel account funds, when distributed to third parties as a benefit to the participant, are considered a gift and are not included in the income of the IDA program participant. Because they are not included in the participant's income, they are not taxable. The interest earned on the main account (IDA deposits by the participant) is taxable to the IDA participant.²

For tax-exempt program contributors there are no tax benefits associated with making the matching contributions or providing any administrative assistance. Taxable entities, such as financial institutions, may receive a tax deduction for matching contributions and administrative or other assistance as charitable contributions, subject to the limits on charitable contributions. Under current law, for individuals, contributions are generally limited to 50% of adjusted gross income (AGI), but may in certain cases be limited to 20% or 30% of AGI. Contributions in excess of the limitation may be carried over to future tax years, subject to a limitation, for up to five years. For corporations, charitable contributions are limited to 10% of an alternative calculation of taxable income,³ with a carryover to future tax years, subject to a limitation of five years.

Using Federal Tax Credits to Fund IDA Programs

The funding structure for the current federal IDA demonstration program is based on discretionary funds appropriated in the Department of Health and Human Services annual budget. As a budget item, the federal IDA demonstration program is subject to the annual budget process, and the possibility that the federal demonstration program is partly funded or not funded at all. Similarly, the refugee program relies on the availability of discretionary funds in the annual agency (ORR) budget, and IDA programs associated with TANF rely on the availability of federal TANF block grants (including TANF authorization). Any future federal IDA program that relies on direct federal funding also would be subject to the federal budget process and the risk of a reduction or elimination of funding.

A tax credit is a form of indirect government spending, a tax expenditure, and is reflected in the budget as a reduction in revenues. Although a tax expenditure can be reduced or eliminated, many think that a program funded by a tax expenditure is less likely to be eliminated than a program funded through direct government spending. In addition, many think that private entities, using tax benefits, can provide certain public goods or services more efficiently, and at a lower cost, than the government.

One major issue with a switch from a budgeted program to a tax expenditure is whether or not the tax expenditure would provide a benefit significant enough to continue a program that was in the past directly funded by the government, or encourage expansion of such a program. The impact of the incentive will depend upon a number of factors including the tax status and general tax situation of the entity making IDA matching contributions or administering IDA accounts. A non-refundable tax credit will have no value to a tax- exempt entity or a tax entity with no tax liability in a given tax year.

In the 108^th Congress, the Savings for Working Families Act of 2003 would have funded IDA programs by creating an individual development account investment credit, rather than using discretionary federal funds, as in the federal demonstration program. IDA programs related to TANF or refugees would have been impacted if the states or the ORR altered their current programs to incorporate private contributions. The legislation would have created an alternative IDA program that might have replaced the current federal IDA demonstration program.⁴

² Internal Revenue Service, Revenue Ruling 99-44, Internal Revenue Bulletin No. 1999-44, Nov. 1, 1999.

³ In general the alternative calculation does not reflect charitable contributions, net operating or capital loss carry-backs, or special deductions for corporations (including certain dividends received deductions, dividends paid, and organizational expenditures).

⁴ For additional information on legislation related to the current IDA programs, see CRS Report RS20534, Individual Development Accounts for TANF Families and Other Low-Income Persons, by Vee Burke.