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Higher Education Tax Benefits: Brief Overview and Budgetary Effects

CRS Report for Congress
Prepared for Members and Committees of Congress
Higher Education Tax Benefits:
Brief Overview and Budgetary Effects
Margot L. Crandall-Hollick
Analyst in Public Finance
March 12, 2013
Congressional Research Service
7-5700
www.crs.gov
R41967
Higher Education Tax Benefits: Brief Overview and Budgetary Effects
Congressional Research Service 1
Introduction
Since 1997, education tax benefits have become an increasingly important component of federal
higher education policy. Fourteen tax benefits are currently available for college students and
their parents to help pay for higher education. The available tax benefits are a mixture of credits,
deductions, exclusions, and other incentives. The benefits can be placed into one of three general
categories: incentives for current year expenses, preferential tax treatment of student loans, and
incentives for saving for college. The Joint Committee on Taxation (JCT) estimates the cost to the
federal government of education tax benefits—the revenue foregone from offering these
benefits—to be $78.9 billion between 2011 and 2015.12
This report provides a brief overview of the higher education tax benefits that are currently
available to students and their families. The report contrasts higher education tax benefits with
traditional student aid, presents a brief history of higher education tax policy over the past 60
years, summarizes key features of the available tax benefits, and provides JCT estimates of
revenue losses resulting from individual tax provisions. The summary is contained in Table 1 and
provides information on various aspects of each tax benefit including the type of benefit (credit,
deduction, etc.), the annual dollar amount of the benefit, what expenses qualify for the benefit,
what level of education the benefit can be claimed for, income levels at which the benefit phases
out, and if the provision is temporary, when it expires. Table 2 contains estimates of the annual
forgone federal revenue attributable to each provision.
Tax Benefits Versus Traditional Student Aid
The federal government provides financial assistance for higher education expenses in two ways:
tax benefits and traditional student aid (loans, grants and work-study assistance). To qualify for
traditional financial aid, students first submit a free application for federal student aid (FAFSA) to
the Department of Education. Financial aid officers at the student’s college or university use the
asset and income information provided by the Department of Education to determine the student’s
federal financial aid award.3 This financial aid is then used to pay for higher education expenses
at the time they are due.
A summary of available traditional financial aid is beyond the scope of this report. For more
information, please see CRS Report RL31618, Campus-Based Student Financial Aid Programs
Under the Higher Education Act, by David P. Smole and Alexandra Hegji; CRS Report R40122,
Federal Student Loans Made Under the Federal Family Education Loan Program and the
William D. Ford Federal Direct Loan Program: Terms and Conditions for Borrowers, by David P.
Smole; and out-of-print CRS Report R41437, Federal Pell Grant Program of the Higher
Education Act: Background, Recent Changes, and Current Legislative Issues, by Shannon M.
Mahan (available from the author upon request).
1 U.S. Congress, Joint Committee on Taxation, Estimates of Federal Tax For Fiscal Years 2011-2015, January 17,
2012, JCS-1-12.
2 These cost estimates do not reflect the legislative changes made by the American Taxpayer Relief Act (P.L. 112-240,
ATRA) as tax expenditure figures which incorporate these changes are not currently available.
3 This information can also be used to calculate any aid provided by the college or university to the student.
Higher Education Tax Benefits: Brief Overview and Budgetary Effects
Congressional Research Service 2
In contrast, most tax-based higher education assistance becomes available after higher education
expenses have been incurred—sometimes several months afterward. Aside from tax preferred
college savings accounts, taxpayers must wait until they file their federal income tax returns to
claim any federal higher education tax benefits. Another difference between the two forms of
educational assistance is that traditional financial aid is often directed toward students with
financial need, while tax benefits are generally available to eligible taxpayers regardless of need.
Brief Historical Perspective of Tax Benefits
Tax benefits for higher education were first introduced nearly 60 years ago. While most of these
benefits were originally structured as deductions and exclusions, which reduce taxable income,
they now include tax credits, which directly reduce tax liability.
Between 1954 and 1996, eight tax benefits for education were enacted:
1. an exclusion for scholarship, fellowship, and tuition reductions;
2. a parental exemption for students age 19 to 23 who were enrolled in college;
3. a business expense deduction for work-related education;
4. an exclusion for employer-provided education assistance;
5. an exclusion for the interest earned on educational savings bonds;
6. an exclusion of qualifying cancelled student loans from taxable income;
7. an unlimited gift tax exclusion for amounts paid by a donor directly to an
educational institution for tuition payments on behalf of the donee; and
8. an exclusion for earnings from qualified tuition programs (QTPs), also known as
Section 529 Plans.
The deduction for student loan interest, which had existed since 1954, was eliminated with the
passage of the Tax Reform Act of 1986 (TRA 86, P.L. 99-514). TRA 86 disallowed all forms of
personal interest deductions other than for mortgage interest.
The Taxpayer Relief Act of 1997 (P.L. 105-34) enacted five new education tax benefits:
1. the Hope Tax Credit;
2. the Lifetime Learning Credit;
3. a reinstatement of the student loan interest deduction;
4. an exclusion for earnings accruing to Education individual retirement accounts
(later renamed Coverdell education savings accounts); and
5. a cancellation of the penalty for early withdrawals from individual retirement
accounts (IRAs).
More recently, 2 additional tax benefits were enacted, bringing the total number of education tax
benefits to 15, although only 14 are in effect in a given year, since the Hope Tax Credit was
temporarily replaced by the American Opportunity Tax Credit (AOTC).
Higher Education Tax Benefits: Brief Overview and Budgetary Effects
Congressional Research Service 3
1. An above-the-line deduction4 for higher education expenses (the “tuition and
fees” deduction) was authorized by the Economic Growth and Tax Relief
Reconciliation Act of 2001 (P.L. 107-16)5.
2. The AOTC was enacted as part of the American Recovery and Reinvestment Act
of 2009 (ARRA; P.L. 111-5). This credit temporarily replaced the Hope Credit
for the 2009 and 2010 school years.
A number of expiring tax benefits and modifications to other tax benefits were extended by the
Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (P.L. 111-
312) through the end of 2012 including the AOTC; the exclusion for employer provided
educational assistance; modifications to the exclusion of scholarships, grants, and tuition
reduction concerning specific scholarships; modifications to the student loan interest deduction;
and modifications to Coverdells. In addition, P.L. 111-312 extended the tuition and fees deduction
through the end of 2011.
The American Taxpayer Relief Act (P.L. 112-240; ATRA) extended several tax provisions or
modifications to tax provisions either permanently or temporarily. For more information on how
ATRA modified these provisions, see the shaded text box below.
The American Taxpayer Relief Act and Education Tax Incentives
• Employer-Provided Education Assistance: Prior to ATRA, this provision was scheduled to expire at the
end of 2012. As a result of ATRA, this tax provision is permanent. Specifically, taxpayers can exclude up to
$5,250 (not adjusted for inflation) of qualifying employer provided educational assistance from taxation.
• Student Loan Interest Deduction: Prior to ATRA, several modifications to this provision (enacted as part of
EGTRRA) were scheduled to expire. Upon their expiration, the deduction could only have been claimed by
eligible taxpayers for the first 60 months of interest payments. In addition, the income phase-out levels would
have been reduced to $40,000-$50,000 ($60,000-$70,000 for married joint filers) adjusted for inflation. As a
result of ATRA, up to $2,500 of student loan interest can be deducted from gross income for the entire duration
of repayment. The amount that can be deducted phases out for taxpayers with income between $55,000-
$70,000 ($110,000-$140,000 for married joint filers), adjusted for inflation. These changes are permanent.
• Coverdell Education Savings Accounts (ESAs): Prior to ATRA, several modifications to this provision
(enacted as part of EGTRRA) were scheduled to expire. Specifically, if these modifications had expired:, the
maximum contribution would have reverted to $500 per beneficiary per year; qualified expenses would have
been limited to higher education expenses; the phase-out range for married taxpayers would have been
$150,000-$160,000; contributions could only have been made until the beneficiary was 18 and the balance of the
account would have to be distributed when the beneficiary turned 30, for both special needs and non-special
needs beneficiaries; a taxpayer could not have claimed an education credit if they also took a tax-free distribution
from their Coverdell; and contributions to a Coverdell would have been subject to a 6% excise tax if
contributions for the same beneficiary were made to a 529 plan. As a result of ATRA: the maximum contribution
amount for a beneficiary is $2,000 per year; qualified expenses include both elementary and secondary school
expenses and higher education expenses; the phaseout range for married taxpayers is $190,000-$220,000 (which
is double the phaseout range for unmarried taxpayers); age limitation are waived for special needs beneficiaries;
beneficiaries who take tax-free distribution for Coverdells can also claim education tax credits (although
expenses paid for with Coverdells funds cannot be used to claim the credits); and contributions can be made to
both a 529 plan and a Coverdell for the same beneficiary without penalty. These changes are permanent.
4 Above-the-line deductions, unlike itemized deductions, are available to all tax filers. Taxpayers who claim the
standard deduction cannot benefit from itemized deductions.
5 This provision was originally scheduled to expire in 2006 under EGTRRA. It was subsequently extended by P.L. 109-
432 (2006-2007), P.L. 110-343 (2008-2009), and P.L. 111-312 (2010 and 2011).
Higher Education Tax Benefits: Brief Overview and Budgetary Effects
Congressional Research Service 4
• National Health Service Corps Scholarships and F. Edward Hebert Armed Forces Health
Professions Scholarship and Financial Assistance Program: Students must generally pay taxes on any
part of a scholarship, fellowship, or tuition reduction that can be attributed to teaching, research, or other
services that have been performed, are being performed, or will be performed. Prior to ATRA, a temporary
exception to this general rule was allowed for funding received from the National Health Service Corps
Scholarships and F. Edward Hebert Armed Forces Health Professions Scholarship and Financial Assistance
Program. As a result of ATRA, this exception was made permanent. Hence, funds from these two scholarships
are not taxable.
• American Opportunity Tax Credit (AOTC): The AOTC was a temporary tax credit enacted as part of the
American Recovery and Reinvestment Act (P.L. 111-5; ARRA) which replaced the Hope Scholarship credit. Prior
to ATRA, the AOTC was in effect from 2009-2012. ATRA extended the credit for five more years, through the
end of 2017. Hence, through the end of 2017, taxpayers are eligible to claim a credit of up to $2,500 ($1,000 of
which is refundable).
• Tuition and Fees Deduction (“above-the-line”): Prior to ATRA the $4,000 above-the line deduction for
tuition and fees had expired at the end of 2011. ATRA reinstated this provision for 2012 and 2013.
Summary and Cost of Current Benefits
Table 1 summarizes the higher education tax benefits currently available. The benefits can be
divided into three groups: incentives for current year higher education expenses, incentives that
provide preferential tax treatment of student loan expenses, and incentives for saving for college.
Generally, a taxpayer cannot claim more than one tax benefit for the same education expense.
The benefits available are either a tax credit, deduction, exemption, or exclusion. While these
terms are sometimes used interchangeably, they are different. It is important to understand the
distinction between the types of incentives:
• Tax credits reduce the amount an individual owes in taxes directly, on a dollar
for dollar basis. Credits are available to all qualified taxpayers, whether they
itemize deductions or not. Credits can be nonrefundable or refundable.
Nonrefundable credits cannot exceed taxes owed, and therefore can only reduce
an individual’s tax liability to zero. Refundable credits can exceed taxes owed,
meaning a taxpayer with no tax liability receives the credit amount as a refund
check. A tax credit is partially refundable if, in cases where the credit is larger
than the taxpayer’s tax liability, the IRS only refunds part of the difference.
Education tax credits include the Hope Credit and Lifetime Learning Credit, both
nonrefundable and the American Opportunity Tax Credit which is partially
refundable.
• Tax deductions reduce the amount of a taxpayer’s income which is subject to
taxation (“taxable income”) by the amount of the deduction. As a result,
deductions reduce a taxpayer’s tax liability, but only by a percentage of the
amount deducted depending on the taxpayer’s highest marginal tax bracket.6
Hence, deductions are generally less valuable than a given dollar amount in tax
credits. Generally, the amount that may be deducted is equal to a portion of some
6 For example, a $4,000 deduction for someone whose highest marginal tax bracket is the 10% bracket will result in a
$400 reduction in that taxpayer’s tax bill. If the taxpayer’s highest marginal tax bracket is the 35% bracket, their tax bill
will fall by $1,400.
Higher Education Tax Benefits: Brief Overview and Budgetary Effects
Congressional Research Service 5
expense incurred. Deductions can either be “above the line” or “itemized.”
Above the line deductions are typically more advantageous than itemized
deductions and may be claimed by most taxpayers. Itemized deductions may only
be claimed by those taxpayers who itemize all their deductions on their tax
returns. The alternative to itemizing is claiming the standard deduction.
Education tax deductions include the business deduction for work related
expenses (an itemized deduction), the deduction for tuition and fees, and the
student loan interest deduction (both “above-the-line” deductions).
• Tax exemptions reduce the amount of a taxpayer’s income which is subject to
taxation, by a fixed dollar amount per exemption claimed. Generally, every
taxpayer is allowed to claim one exemption for themselves, one exemption for a
spouse, and one for each dependent. Exemptions function similarly to deductions
in that they reduce the income that is subject to taxation, but they are based on
fixed amount per person instead of actual expenses. An exemption’s value to a
taxpayer is also similar to the value of a deduction in terms of being proportional
to a taxpayer’s highest marginal tax bracket. Parents of students between the ages
of 19 and 23 are eligible for a personal tax exemption for their children.
• Tax exclusions are amounts of income that are not included as income for tax
purposes because the tax code explicitly excludes—or exempts—them from
taxation. Education tax exclusions include the exclusion of certain scholarships,
grants, and tuition reductions, the exclusion of employer provided educational
assistance, the exclusion of qualifying cancelled student loans, and the exclusion
of direct transfers to educational institutions.
As Table 1 shows, there are a number of limitations to the available tax benefits. Some benefits
are subject to an annual limit, or “cap.” For example, the maximum annual American Opportunity
Tax Credit that may be claimed is $2,500. A number of the tax benefits may be limited by the
type of “qualifying” expenses they are used to offset. For some tax benefits, only tuition and
required fees qualify. Generally fees that must be paid to the educational institution as a condition
of enrollment or attendance are considered “required fees.” Other tax benefits can be used to
offset course-related books, supplies, and materials. And still other benefits may be used to cover
travel and other expenses.
A number of higher education tax benefits also have income limitations. When an income
limitation does exist, it is in the form of an income phase-out range. Taxpayers with incomes
below the start of the phase-out range are eligible to claim the maximum tax benefit amount. The
amount of the credit that can be claimed is then reduced for individuals with incomes within the
phase-out range, and is zero for those with incomes above the phase-out range. In addition, the
expiration date for the provision, if temporary, is provided.
Table 2 presents the JCT cost estimates for each available tax benefit. The JCT advises that these
estimates cannot be simply summed to estimate the aggregate revenue loss from multiple tax
provisions. This is because of interaction effects. When the revenue loss associated with a specific
tax provision is estimated, the estimate is made assuming that there are no changes in other
provisions or in taxpayer behavior. When individual tax expenditures are summed, the interaction
effects may lead to different revenue loss estimates. Consequently, aggregate tax expenditure
estimates, derived from summing the estimated revenue effects of individual tax expenditure
provisions, are unlikely to reflect the actual change in federal receipts associated with removing
various tax provisions.
Higher Education Tax Benefits: Brief Overview and Budgetary Effects
Congressional Research Service 6
CRS-7
Table 1. Overview of Education Tax Benefits, 2013
Type of Benefit Annual Limit Qualifying Expenses
Qualifying
Education Level
Income Phase-out
Range Expiration
TAX BENEFITS FOR TUITION AND RELATED EXPENSES
American
Opportunity Credit
IRC Sec. 25A
Tax Credit- Partially
Refundable
40% of credit may be
refundable (up to
$1,000)
$2,500 credit per
student
(1) Tuition and required enrollment
fees
(2) Course-related books, supplies
and equipment
first 4 years of
postsecondary
education
(undergraduate)
$80K-$90K
$160K-$180K
(married joint)
December 31, 2017
HOPE Credita
IRC Sec. 25A
Tax Credit-
Nonrefundable
$1,800 credit per
student
(2008 levels)a
(1) Tuition and required enrollment
fees
first 2 years of
postsecondary
education
(undergraduate)
$48K-$58K
$96K-$116K
(married joint)
(2008 levels)a
None
Lifetime Learning
Credit
IRC Sec. 25A
Tax Credit-
Nonrefundable
$2,000 credit per tax
return
(1) Tuition and required enrollment
fees
Undergraduate
and Graduate
Courses to
acquire or
improve job skills
$52K-$62K
$104K-$124K
(married joint)
None
Deduction for
Tuition and Fees
IRC Sec. 222
Deduction (“Above the
Line”) of qualified
expenses from gross
income
$4,000 deduction (1) Tuition and required enrollment
fees
Undergraduate
and Graduate
$65K-$80K
$130K-$160K
(married joint)
December 31, 2013
Business Deduction
for Work Related
Education Expenses
IRC Sec. 162
Reg. §1.162-5
Deduction (Itemized)
of qualified expenses
from AGI
None (1) Tuition and required enrollment
fees
(2) Transportation and travel
(3) Other necessary expenses
Education must be
required by
employer or law
to keep present
job, salary, status
or maintain or
improve job skills
None None
CRS-8
Type of Benefit Annual Limit Qualifying Expenses
Qualifying
Education Level
Income Phase-out
Range Expiration
Exclusion of
Scholarships,
Grants, and Tuition
Reductions
IRC Sec. 117
Exclusion from taxable
income if scholarship,
grant is used to pay
qualifying education
expenses.
In addition, the
National Health Service
Corps Scholarships and
F. Edward Hebert
Armed Forces Health
Professions Scholarship
and Financial
Assistance Program are
excludible from
taxation.
None (1) Tuition and required enrollment
fees
(2) Course-related books, supplies
and equipment
Undergraduate
and Graduate
None None
Exclusion of
Employer Provided
Educational
Assistance
IRC Sec. 127
Exclusion from taxable
income
$5,250 exclusion (1) Tuition and required enrollment
fees
(2) Course-related books, supplies
and equipment
Undergraduate
and Graduate
None None
Parental Personal
Exemption for
Dependent
Students 19-23
Years Old
IRC Sec. 151 & 152
Exemption of fixed
amount per dependent
$3,800 per dependent NA Student must be
under 24 by the
end of the tax
year and enrolled
full time at a
qualifying
institution
None None
TAX BENEFITS FOR STUDENT LOANS
Student Loan
Interest Deduction
IRC Sec. 221
Deduction (“Above the
line” ) of interest paid
$2,500 (1) Tuition and required enrollment
fees
(2) Course-related books, supplies
and equipment
(3) Room and board
(4) Other necessary expenses
(including transportation)
Undergraduate
and Graduate
$60K-$75K
$125K-$155K
(married joint)
None
CRS-9
Type of Benefit Annual Limit Qualifying Expenses
Qualifying
Education Level
Income Phase-out
Range Expiration
Exclusion of
Qualifying Cancelled
Student Loans
IRC Sec. 108(f)
Exclusion from taxable
income
None (1) Tuition and required enrollment
fees
(2) Course-related books, supplies
and equipment
(3) Room and board
(4) Other necessary expenses
(including transportation)
Undergraduate
and Graduate
None None
TAX BENEFITS FOR EDUCATION SAVINGS PLANS
Qualified Tuition
Programs (529
Plans)
IRC Sec. 529
Earnings not taxed None (1) Tuition and required enrollment
fees
(2) Books, supplies and equipment
(3) Expenses for special needs services
(4) Room and board if at least halftime
student
Undergraduate
and Graduate
None None
Coverdell Education
Savings Accountb
IRC Sec. 530
Earnings not taxed $2,000 contribution
per beneficiary
K-12 Expenses
(1) Tuition and fees
(2) Books, supplies and equipment
(3) Academic tutoring
(4) Special needs services
(5) Room and board
(6) Uniforms
(7) Transportation
(8) Required supplementary items and
services
(9) The purchase of a computer if it is
used by the beneficiary or their family.
Higher Education Expenses
(1) Tuition and required enrollment
Fees
(2) Books, Supplies and Equipment
(3) Expenses for special needs services
(4) Payments to QTP
(5)Room and board if at least half-time
student
K-12
Undergraduate
and Graduate
$95K-$110K
$190K-$220K
(married joint)
None
CRS-10
Type of Benefit Annual Limit Qualifying Expenses
Qualifying
Education Level
Income Phase-out
Range Expiration
Exclusion of
Interest on
Education Savings
Bonds
IRC. Sec. 135
Interest not taxed Amount of qualified
education expenses
(1) Payments to Coverdell ESAs
(2) Payments to QTPs
Undergraduate
and Graduate
$72,850-$87,850
$109,250-
$139.250
(married joint)
None
Early Withdrawals
from IRAs
IRC Sec. 72(t)
No 10% additional tax
on early withdrawal
Amount of qualified
education expenses
(1) Tuition and required enrollment
fees
(2) Books, supplies and equipment
(3) Expenses for special needs services
(4) Room and board if at least halftime
student
Undergraduate
and Graduate
None None
Uniform Transfers
to Minors
IRC Sec. 2503(e)
Exclusion from income
of direct transfer to
educational institution
Unlimited (1) Amounts paid directly to
educational institution for tuition
Undergraduate
and Graduate
None None
Sources: Internal Revenue Service, Publication 970: Tax Benefits for Education 201l; U.S. Congress, Joint Committee on Taxation, List Of Expiring Federal Tax Provisions 2010-
2020, 112th Congress, January 21, 2011, JCX-2-11; CCH Tax Law Editors, U.S. Master Tax Guide 2011; and Internal Revenue Service, Revenue Procedure 2011-52.
Notes: NA = not applicable.
a. The parameters for the Hope Credit are for 2008, the most recent year for which the credit was in effect. The credit is scheduled to return in 2013, at which time the
annual limit and income phase-out ranges will be adjusted for inflation.
b. The income phaseouts for Coverdells apply to any individual who contributes to the Coverdell (including the beneficiary).
Higher Education Tax Benefits: Brief Overview and Budgetary Effects
Congressional Research Service 11
Table 2. Estimated Budgetary Impact of Tax Benefits for
Higher Education Expenses, 2013-2017
(billions of dollars)
Tax Benefit 2013 2014 2015 2016 2017 Total
American Opportunity Tax Credit (AOTC)Error! Reference source not found.,a
and Lifetime Learning Credit
20.1 24.5 26.8 27.4 27.6 126.4
Parental Personal Exemption for Students aged 19 to 23 4.8 5.0 5.1 5.2 5.3 25.4
Exclusion of Scholarship and Fellowship Income 2.5 2.7 2.8 3.0 3.1 14.1
Deduction for Student Loan Interest 1.3 1.4 1.4 1.5 1.5 7.1
Exclusion of Employer-Provided Education Benefits 1.1 1.2 1.2 1.2 1.2 5.9
Exclusion of Earnings of Qualified Tuition Programs (529 Plans) 0.8 0.9 1.1 1.2 1.3 5.3
Exclusion of Tuition Reductions 0.2 0.2 0.2 0.2 0.3 1.1
Exclusion of Certain Discharged Student Loans 0.2 0.2 0.2 0.2 0.2 1.0
Deduction for Tuition and Feesc 0.7 0.2 0.0 0.0 0.0 0.9
Exclusion of Earnings of Coverdell Education Savings Accounts 0.1 0.1 0.1 0.1 0.1 0.6
Exclusion of Interest On Education Savings Bonds d d d d d d
Total 31.8 26.4 38.9 40.0 40.6 186.9
Source: Joint Committee on Taxation, Estimates of Federal Tax For Fiscal Years 2012-2017, February 1, 2013,
JCS-1-13.
Notes: A positive estimate corresponds to a federal revenue cost. Items may not sum due to rounding.
a. This provision was extended by P.L. 112-240 through the end of 2017. Beginning in 2018, the AOTC is
scheduled to expire and revert back to the non-refundable Hope Credit.
b. These estimates include the outlays resulting from the refundable portion of the AOTC.
c. This provision was extended by P.L. 112-240 through the end of 2013.
d. Revenue losses for 2011-2015 are less than $50 million.

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