Above-the-line For 2004 or 2005, the Same as Hope credit. No restrictions. maximum deduction is: (1) $4,000 for an whose adjusted gross deduction is not Qualified is taken to acquire or Coordination with for higher education expenses No credit is allowed Same as Hope credit. Above-the-line deduction cannot be respect to a student Lifetime Learning credit is claimed for such student in the same year. No deduction is allowed for any expense for which a allowed under any the Code. Reasons for Change Combining the Hope and Lifetime Learning credits and the deduction for higher education expenses into a single credit for higher education expenses would promote simplicity in delivering education tax benefits.100 Additionally, providing such benefits on a per-student basis, rather than a per tax return basis, would promote greater fairness by allowing the credit to vary more directly with the number of students in a family. Description of Proposal The proposal combines the Hope and Lifetime Learning credits and the above-the-line deduction for qualified higher education expenses into a single credit. The credit applies on a per-student basis, as under the Hope credit, and, as under the Lifetime Learning credit, applies to qualified education expenses for both graduate and undergraduate education without regard to enrollment status (i.e., halftime or otherwise). The credit equals 25 percent of the first $10,000 dollars of qualified expenses per student. The otherwise allowable aggregate credit per tax return is phased out by $50 for each $1,000 that adjusted gross income exceeds $70,000 ($140,000 if married filing a joint return). The credit is allowed against the alternative minimum tax. The credit rate, expense limitation, and phaseout ranges were chosen to create an approximately revenue neutral proposal over the period 2006-2014101 under the assumption that the baseline includes permanent extension of the above-the-line deduction and extension of provisions allowing nonrefundable personal credits against the alternative minimum tax. These assumptions were made for purposes of illustrating a possible credit that provides benefits comparable to those based on the law in effect for 2005. A revenue estimate of this proposal, which would be determined relative to present law (and therefore would incorporate the expiration of all expiring provisions), would not be revenue neutral. In particular, the proposal does not completely reflect the revenue loss attributable to allowing the credit against the alternative minimum tax or allowing the credit for those taxpayers phased out of the present-law Hope and Lifetime Learning Credits, but otherwise eligible for the above-the-line deduction for higher education expense if the deduction were extended. The $10,000 expense limit and the phaseout thresholds are the 2006 levels. The expense limit and the phaseout thresholds are indexed for inflation. 100 The complexity of the present-law rules was previously noted by the staff of the Joint Committee on Taxation in the 2001 simplification study. The proposal here is similar to the recommendation in the simplification study. Joint Committee on Taxation, Study of the Overall State of the Federal Tax System and Recommendations for Simplification, Pursuant to Section 8022(3)(B) of the Internal Revenue Code of 1986 (JCS-3-01), April 2001, at 122, 126-30. Effective Date The proposal is effective with respect to taxable years beginning after the date of enactment. Discussion The proposal embodies two principal policy objectives. The first is simplification. The three present-law benefits are substantially similar in their objectives; combining them into a single benefit can achieve the same general policy in a less complicated manner. 102 The second policy objective is to achieve a more equitable benefit by making the benefit apply on a per student basis rather than a per tax-return basis. The credit structure (as opposed to a deduction) is adopted, and an income-based phaseout of the benefit is retained, on the grounds that educational expenses do not warrant a reduced tax liability as a result of ability-to-pay principles. Rather, the primary function of the educational benefit is to lower the price of education (accomplished via the credit) to a particular group in order to encourage pursuit of higher education. The rationale for the credit approach rather than the deduction suggests that the credit should be refundable, because the rationale for subsidizing the price of education does not depend on having a tax liability. Nevertheless, refundable credits are administratively complex and potentially more subject to fraudulent claims that are difficult to recoup. Additionally, there are Federal programs, such as the Pell Grant program, that provide direct grants for education to a population that is generally similar to the population that would be eligible for a refundable credit. Thus, a mechanism already exists to assist this demographic group, which could be expanded by Congress as necessary. The proposal does not provide for refundability because Congress has not in the past permitted refundability with respect to education benefits. The credit structure would readily permit refundability should Congress desire to provide for it. The proposal does not include a half-time or greater enrollment requirement on the grounds that many students from lower-income families cannot afford to attend school on a halftime or greater basis, either as a result of the expenses of half-time or greater enrollment or as a result of the greater foregone earnings from reduced employment of the student that a half-time or greater enrollment requirement would likely entail. 102 Further simplification could be achieved across other tax benefits for education. For example, separately, the President's Fiscal Year 2005 budget proposal and the staff of the Joint Committee on Taxation have recommended that the definition of qualified education expenses be conformed more generally across provisions of the Code. See Office of Management and Budget, Budget of the United States Government, Fiscal Year 2005; and, Joint Committee on Taxation, Study of the Overall State of the Federal Tax System and Recommendations for Simplification, Pursuant to Section 8022(3)(B) of the Internal Revenue Code of 1986 (JCS-3-01), April 2001, at 122-26. C. Repeal Exclusion for Qualified Tuition Reductions (sec. 117(d)) Present Law Qualified tuition reductions Present law provides an exclusion from gross income and wages for amounts received as a qualified tuition reduction. 103 In general, a qualified tuition reduction is the amount of any reduction in tuition provided to employees of qualifying educational organizations for the education below the graduate level (including primary and secondary school) of the employee (and the employee's spouse and dependents)104 at such organizations or other qualifying educational organizations. A graduate student at a qualifying educational organization who is engaged in teaching or research activities at the organization may exclude from gross income and wages any amount received as a qualified tuition reduction even if the education provided is not below the graduate level. For a tuition reduction to qualify for the exclusion, the organization must be an educational organization which normally maintains a regular faculty and curriculum and normally has a regularly-enrolled body of pupils or students in attendance at the place where its educational activities are regularly carried on. A qualified tuition reduction which is provided with respect to a highly compensated employee qualifies for the exclusion only if it meets certain nondiscrimination rules. Specifically, the exclusion must be offered on substantially the same terms to each member of a group of employees which is defined under a reasonable classification established by the employer which does not discriminate in favor of highly compensated employees. For this purpose, the term "highly compensated employee" means any employee who (1) was a fivepercent owner of the employer at any time during the year or (2) for the preceding year, had compensation from the employer in excess of $95,000 (for 2005) and if the employer elects, was in the top-paid group of employees for such year. 105 The exclusion for qualified tuition reductions generally does not apply to any amount received by a student that represents payment for teaching, research, or other services by the student required as a condition for receiving the tuition reduction. Payments for such services are includible in gross income and wages. 103 104 Secs. 117(d) and 3121(a)(20). Certain other individuals may also be treated as employees for purposes of this rule, including retired and disabled employees and surviving spouses of employees. Sec. 117(d)(2)(B). 105 Sec. 414(q). This is the same definition used for purpose of the nondiscrimination rules applicable to qualified retirement plans. Other tax benefits for education expenses Present law provides a variety of other tax benefits relating to education. These include: the Hope tax credit; the Lifetime Learning credit; an above-the-line deduction of up to $4,000 of higher education expenses; an exclusion of up to $5,250 annually for employer-provided education assistance; qualified scholarships; section 529 qualified tuition programs; Coverdell education savings accounts; an exclusion of earnings on education savings bonds; a deduction for student loan interest; and an exclusion of income for student loan forgiveness." Reasons for Change 106 The exclusion for qualified tuition reductions raises fairness concerns because it is available only to a limited group of taxpayers, as compared to other present-law provisions which provide tax benefits relating to education much more broadly. Repeal of the provision would simplify the law and remove a potential source of noncompliance. 107 Description of Proposal The proposal repeals the exclusion for qualified tuition reductions. Under the proposal, such benefits are included in gross income and are treated as wages for employment tax purposes. Tuition reductions that are includible in income under the proposal would be eligible for the present-law tax benefits for education expenses, provided the requirements for such benefits are otherwise satisfied. Effective Date The proposal is effective with respect to taxable years beginning after date of enactment. Discussion The exclusion for qualified tuition reductions is available only to a limited group of taxpayers. It is not available to individuals working in fields other than education and, within the education field, may be available primarily to those working for educational institutions which have the greatest resources and by employees of the most resource-rich schools within such 106 Some of these provisions apply to higher education, while others also apply to elementary and secondary education. For example, the Coverdell education savings accounts may be used to provide for primary and secondary education on a tax-favored basis. A proposal to combine the above-the-line deduction, the Hope credit and the Lifetime Learning credit is described in Part II.B., of the report. 107 Tuition reductions are also excludable from income and wages if they qualify: (1) as a working condition fringe benefit (sec. 132(d)), i.e., if the cost of the education would be deductible as a business expense paid by the employee; or (2) for the exclusion for employerprovided education assistance (sec. 127). In many cases, the section 127 exclusion will not apply, because that exclusion applies to education provided to the employee, but not to the employee's spouse or dependents. |