CRS Updates Report on Education Tax Benefit Permanence

EGTRRA also extended through December 31, 2010, the temporary exclusion for employer-provided educational assistance, which was set to expire for courses beginning after December 31, 2001. The act allowed the $5,250 annual limit on education assistance to again cover graduate as well as undergraduate courses. The income exclusion originated with enactment of the Revenue Act of 1978 (P.L. 95-600).²

Although the above-the-line deduction for classroom expenses of elementary and secondary (K-12) school educators often is included in conversations about education tax benefits, its purpose differs from that of the other provisions. The educator deduction, initially authorized in the Job Creation and Worker Assistance Act of 2002 (P.L. 107-147), is intended to help elementary and secondary school teachers among other school personnel defray expenditures for classroom materials they voluntarily make to enhance the quality of students' education. Like the Higher Education Deduction, it most recently was reauthorized retroactive to its expiration date and extended to December 31, 2007, in P.L. 109-432. The classroom expense deduction is available to teachers, instructors, counselors, principals, and aides employed at least 900 hours in a school year at public and private K-12 schools. It is limited to $250 for purchases of certain items (e.g., books and supplies) used by educators in the classroom.³

The Education Savings Bond program, which became effective in 1990 pursuant to Section 6009 of the Technical and Miscellaneous Revenue Act of 1988 (P.L. 100-647), is permanent as well. Bond owners who apply the principal and interest of Series EE and I bonds toward tuition and related fees on behalf of a dependent student at the undergraduate or graduate level in the same year in which the bonds are redeemed may be eligible to exclude the interest from their taxable income. The bond must be registered in the taxpayer's and/or spouse's name rather than the dependent's name. The taxpayer must claim an exemption for the student and must meet AGI limits in the year in which bond proceeds are used toward tuition and related fees. In tax year 2007, the exclusion begins to phase out at an AGI above $65,600 for a single filer and above $98,400 for a joint filer. The exclusion cannot be taken by single filers whose AGI is at least $80,600 (for joint filers, $128,400). AGI limits may be adjusted annually for inflation.⁶

EGTRRA changed temporarily, typically for tax years 2002 through 2010, certain aspects of three other permanently authorized education tax benefits. Two of the benefits are meant to encourage individuals to save toward future educational expenses (i.e., the Coverdell Education Savings Accounts and Section 529 Programs). The third is the Student Loan Interest Deduction.

The Coverdell Education Savings Account (CESA) is a trust or custodial account that originated as the Education IRA in P.L. 105-34 for the purpose of providing a tax-free savings vehicle for higher education expenses. The account became available in 1998. The appeal of the permanently authorized CESA was enhanced in EGTRRA starting in tax year 2002, but on January 1, 2011, absent congressional action, the following modifications will be supplanted by their prior versions:⁷

• The annual limit on an individual's after-tax contributions to a beneficiary's account was quadrupled to $2,000 from $500.

• The "marriage penalty" was eliminated as well, such that a joint filer with an AGI below $220,000 is now eligible to make contributions to CESAs compared to prior law when their AGI had to be below $160,000.

• Tax-free CESA withdrawals were extended from payment of qualified higher education expenses (e.g., tuition, books, and supplies) to payment of qualified K-12 expenses (e.g., tuition, tutoring, computers, supplies, and uniforms).

• Higher education expenses were expanded to include, for example, special needs services for special needs beneficiaries.⁸ For special needs beneficiaries, the under-18 age limit for contributions to CESAs was eliminated, as was the requirement that funds in CESAs generally be distributed to beneficiaries by age 30.

• The date by which contributions to CESAs can be made was extended to the tax filing date for that year. The length of time for corrective withdrawals of excess contributions and associated earnings to avoid a 6% excise tax was extended to June 1 from the due date of the beneficiary's tax return for the contribution year.

• The definition of a beneficiary's family members was extended to first cousins into whose accounts funds may be rolled over tax-free from existing accounts and who may be named as new beneficiaries of existing accounts. This too is the case for Section 529 Plans, discussed below.

• Before determining the qualified expenses that CESA withdrawals can offset, expenses must be reduced by the amount of tax-free scholarships and financial aid (e.g., Pell Grants). Taxpayers then can claim a Hope or Lifetime Credit or a Higher Education Deduction for the remaining tuition and fees of a given student and make tax-free withdrawals from CESAs if the withdrawals do not go toward the same expenses for which the other benefits are claimed. (Before January 1, 2002, taxpayers could not claim the credits unless they waived the tax-free treatment of CESA withdrawals.) If, through December 31, 2010, CESA withdrawals become taxable because of receipt of tax-free assistance and of education credits or deductions, the withdrawals will not be subject to the 10% tax penalty usually assessed nonqualified distributions.

An above-the-line deduction from taxable income of up to $2,500 in annual interest payments on student loans was permanently authorized as of 1998 in the Taxpayer Relief Act of 1997. The loans must have been used toward the cost of attendance for students enrolled at least half-time in undergraduate and graduate programs leading to an educational credential. In tax years 2002 through 2010, the student loan interest deduction no longer is restricted to interest paid within the first 60 months during which interest payments are required. Unlike under prior law, EGTRRA also allows voluntary payments of interest to be deducted over the period. In addition, the act raises the AGI of a taxpayer who may claim the tax benefit (from $55,000 to $65,000 for a single filer and from $75,000 to $130,000 for a joint filer), effective in 2002. From tax year 2003 through 2010, the income limits may be adjusted annually for inflation; thereafter, absent congressional action, AGI will revert to pre-EGTRRA levels.

Activity During the 109th Congress

Two pieces of legislation were enacted during the 109th Congress that pertain to the education tax benefits previously discussed in this report. The first -- the Pension Protection Act of 2006, P.L. 109-280 -- included making permanent the enhancements to the Section 529 Program provided in EGTRRA. The second -- the Tax Relief and Health Care Act of 2006 (P.L. 109-432) -- included extending the Higher Education Deduction and Educator Classroom Expense Deduction through December 31, 2007.

Activity During the 110th Congress

As it had proposed for FY2008, the Administration's FY2009 revenue proposals would permanently extend the enhancements that EGTRRA made to the aforementioned education tax benefits -- with the exception of the Higher Education Deduction. The Administration also would make permanent the deduction for classroom expenses of eligible educators and allow the Saver's Credit for contributions to Section 529 plans.¹⁰

Some Members appear to support retaining the now-expired Higher Education Deduction as evidenced by legislation to expand the tax provision, extend it, or make it permanent (e.g., H.R. 193, H.R. 411, H.R. 686, H.R. 1407, H.R. 1437, H.R. 2411, H.R. 2734, H.R. 2782, H.R. 3388, H.R. 3630, H.R. 3879, H.R. 3906, H.R. 4086). S. 359 would remove applicability of EGTRRA's sunset provision to the Higher Education Deduction and enhance it, while also amending the deduction's definition of an eligible student to conform to that of the Hope credit (i.e., carrying at least half the normal full-time work load for the course of study being pursued).

Members also appear to favor simplifying use of the federal tax code to help individuals better afford college.¹¹ For example, S. 614 and S. 851 would replace the Higher Education Deduction and the two education credits and with one credit. Proposals to eliminate the Higher Education Deduction and Lifetime Learning Credit or to retain them but substitute the Hope Credit's definition of an eligible student would curtail people's access to tax benefits that reduce the cost of taking courses during one's working life to acquire or improve job skills.

² For additional information see CRS Report 97-243, The Current Tax Status of Employer Education Assistance, by Linda Levine.

³ For additional information see CRS Report RS21682, The Tax Deduction for Classroom Expenses of Elementary and Secondary School Teachers, by Linda Levine. (Hereafter cited as CRS Report RS21682, The Tax Deduction for Classroom Expenses of Elementary and Secondary School Teachers.)

⁴ To take advantage of nonrefundable credits, taxpayers must have income tax liabilities remaining after they have taken personal/dependency exemptions, standard or itemized deductions, and other personal credits.

⁵ For additional information, see CRS Report RL31129, Higher Education Tax Credits and Deduction.

⁶ For additional information see CRS Report RL32155, Tax-Favored Higher Education Savings Benefits and Their Relationship to Traditional Federal Student Aid, by Linda Levine and Charmaine Mercer. (Hereafter cited as CRS Report RL32155, Tax-Favored Higher Education Savings Benefits.)

⁷ Ibid.

⁸ Definitional changes were made to room and board as well. The changes similarly apply to Section 529 Programs.

⁹ For additional information, see CRS Report RL32155, Tax-Favored Higher Education Savings Benefits; and CRS Report RL31214, Saving for College Through Qualified Tuition (Section 529) Programs, both by Linda Levine.

¹⁰ Legislative activity related to the educator deduction is tracked in CRS Report RS21682, The Tax Deduction for Classroom Expenses of Elementary and Secondary School Teachers.

¹¹ For examples of the complexity that families face choosing between the three tax provisions see CRS Report RL31129, Higher Education Tax Credits and Deduction.