97-915 EPW
CRS Report for Congress
Received through the CRS Web
Tax Benefits for Education
in the Taxpayer Relief Act of 1997
September 30, 1997
Bob Lyke
Specialist in Social Legislation
Education and Public Welfare Division
Congressional Research Service ˜ The Library of Congress
Tax Benefits for Education
in the Taxpayer Relief Act of 1997
Summary
The Taxpayer Relief Act of 1997 (P.L. 105-34) substantially expanded tax
benefits for education. Four widely publicized provisions — two new tax credits, new
tax-exempt education savings accounts, and a new deduction for interest payments
on education loans — can help families pay for college and other postsecondary
education expenses.
Other provisions in the legislation extended the tax exclusion for employer
education assistance, exempted individual retirement account (IRA) withdrawals used
for higher education from early withdrawal penalties, expanded the tax exclusion for
student loans that are forgiven, and authorized an enhanced deduction for corporate
contributions of computer technology and equipment to elementary and secondary
schools. The legislation also created new qualified zone academy bonds for public
school construction
Contents
Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 1
Tax Credits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 2
Education IRAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 3
State Tuition Programs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
IRA Early Withdrawal Penalty . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Interest Deduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4
Employer Education Assistance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Student Loan Forgiveness . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 5
Contributions of Computer Technology and Equipment . . . . . . . . . . . . . . . 6
Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6
Provisions not included in Act . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 7
Tax Benefits for Education
in the Taxpayer Relief Act of 1997
Introduction
The Taxpayer Relief Act of 1997 that the President signed on August 5, 1997,
contained tax benefits for higher education expenses paid by students and their
families. With some exceptions, qualifying expenses must be incurred at institutions
eligible to participate in federal student aid programs under Title IV of the Higher
Education Act (hereafter called Title IV HEA institutions). Nearly all public and
private colleges and universities have this eligibility, as do many vocational and
proprietary schools (for-profit trade and technical schools). The Act also made other
changes that affect bonds for school construction and donations of computers to
elementary and secondary schools. While the Internal Revenue Code previously had
provisions favoring education, the new legislation marks a significant expansion in the
use of tax policy to encourage enrollment and to help families and communities pay
for schools. The numerous special tax benefits for education and other purposes
distinguishes the Taxpayer Relief Act from the Tax Reform Act of 1986 (P.L. 99-
514), which generally reduced special incentives. For further information about these
incentives, see CRS Report 97-854, The Taxpayer Relief Act of 1997: An Overview,
by David L. Brumbaugh.
The new legislation offers families multiple ways to get tax subsidies for higher
education. They can benefit in years when they save for college, when they pay
tuition costs, and when they repay loans. The legislation thus supports different
approaches families might take toward financing postsecondary education and gives
them flexibility to change as their plans evolve.
At the same time, the new options make financial planning for college more
complicated. The extent to which the tax benefits will supplement or supplant
assistance provided by the Higher Education Act is not yet clear. The added
complexity raises concerns that families in similar economic circumstances will receive
different levels of benefits.
It is also unclear whether the new tax benefits, estimated to cost nearly $40
billion over FY1997 through FY2002, will result in additional enrollment or other
investment in education. The benefits may influence some students to continue their
studies (particularly after obtaining their initial degree) and some to consider a wider
range of schools. However, it is likely that most of the benefits will accrue to families
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whose students would enroll anyway and that some will be captured by the schools
through higher tuition.1
This report summarizes highlights of education provisions of the Taxpayer Relief
Act. It provides general information and does not cover all provisions. For more
details, readers might consult either the Act itself or the statement of the conference
committee, both of which are printed in part II of the Congressional Record for July
30, 1997.
Tax Credits
The Taxpayer Relief Act of 1997 authorized two new tax credits for family
postsecondary education expenses. The HOPE Scholarship Credit, effective
January 1, 1998, is equal to 100% of the first $1,000 of qualified tuition and fees and
50% of the next $1,000 that taxpayers pay for themselves, their spouse, or their
dependents.2 The credit may be claimed for 2 taxable years with respect to each
student, provided the student has not completed the first 2 years of postsecondary
education before the beginning of the year for which the credit is claimed. An eligible
student must be enrolled (or accepted for enrollment) in a degree, certificate, or other
program leading to a recognized educational credential and must carry at least one-
half the normal full-time work load. The HOPE credit is not allowed for a student
who has been convicted of a felony drug offense.
The Lifetime Learning Credit, effective July 1, 1998, is equal to 20% of the
first $5,000 of qualified tuition and fees (the first $10,000 after 2002) that taxpayers
pay for themselves, their spouse, or their dependents. The credit may be claimed any
number of years for any level of postsecondary education; it can also apply to students
who are enrolled in a single course to acquire or improve job skills.
For a particular student, either the HOPE credit, the Lifetime Learning credit,
or the exclusion of distributions from education IRAs (described below) may be
claimed in 1 year. However, all three tax benefits might be claimed the same year,
even by one taxpayer, with respect to three different students.
The HOPE and Lifetime Learning credits are allowed for payments made to Title
IV HEA institutions. Education involving sports, games, and hobbies does not qualify
unless required as part of a degree program. Qualified tuition and fees do not include
amounts attributable to scholarships, veterans’ educational assistance, or most other
payments that are excludable from gross income for tax purposes (such as certain
employer tuition reimbursements). However, payments made from gifts and
inheritances may be considered for the credits, as may payments made from loans.
1For a discussion of these issues, see CRS Report 97-581, Tax Subsidies for Higher
Education: An Analysis of the Administration’s Proposals, by Jane Gravelle and Dennis
Zimmerman.
The
2
limits on qualified tuition and fees for the credits and the modified adjusted gross
income limits are indexed for inflation after 2001.
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To give a simple example, consider an independent student who attends a school
with tuition and fees charges of $5,000. If the student receives a $1,000 Pell Grant,
a $1,000 scholarship from the school, and a $1,500 loan, qualified tuition and fees
would equal $3,000 (this is, $5,000 minus the two scholarships). Subject to
limitations in the following paragraph, the HOPE credit (if the student were eligible)
would be $1,500 (that is, 100% of the first $1,000 paid and 50% of the next $1,000).
The Lifetime Learning credit (if the student were not eligible for the HOPE credit)
would be $600 (20% of the $3,000 paid).
The education credits are phased out for taxpayers with modified adjusted gross
incomes over $40,000 ($80,000 in the case of a joint return). The two credits are not
refundable: the sum of them and other nonrefundable credits is limited to the excess
of the taxpayer’s regular income tax liability over the tentative minimum tax.3 Thus
some middle income families may receive smaller education credits than would first
appear to be the case. Taxpayers are not eligible for either the HOPE or Lifetime
Learning credit if they can be claimed as dependents by another taxpayer (for
example, students who can be claimed by their parents); however, the payments they
make may be counted by the taxpayer who claims their exemption.
Education IRAs
The Taxpayer Relief Act authorized new education savings accounts which, like
individual retirement accounts generally, are designated trusts held by banks and other
financial entities. Custodial accounts may be treated as such trusts. Beginning
January 1, 1998, annual contributions up to $500 may be made until the beneficiary
for whom the account is established turns 18. The annual allowable contribution is
reduced for contributors (not restricted to parents) with modified adjusted gross
incomes over $95,000 ($150,000 in the case of a joint return). Contributions may not
be made in years when contributions for the beneficiary are made by anyone to
qualified state tuition programs.
Contributions to education IRAs are not deductible, but accounts are exempt
from taxation and distributions are excluded from the beneficiary’s gross income if
used for qualified higher education expenses. These expenses include tuition, fees,
books, supplies, and equipment required for enrollment or attendance at Title IV HEA
institutions, plus (in the case of students attending at least half-time) reasonable costs
for room and board. The expenses do not include amounts attributable to
scholarships, veterans’ educational assistance, or most other payments that are
excludable from gross income. Distributions are included in gross income and subject
to a 10% penalty to the extent account earnings are not used for qualified expenses;
for this purpose, it is assumed that contributions and earnings are used proportionally
3The tentative minimum tax is calculated under the formula for determining the
alternative minimum tax (AMT). Taxpayers can have a positive tentative minimum tax (and
thus a reduction of their allowable credits) even though they do not have an AMT liability.
For purposes of determining the limitation on nonrefundable credits, the regular tax liability
and the tentative minimum tax are calculated in special ways.
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for qualified and non-qualified expenses.4 The 10% penalty does not apply in certain
cases. Education IRA distributions cannot be excluded the same year that either the
HOPE or Lifetime Learning credit is claimed for a particular student.
State Tuition Programs
The Small Business Job Protection Act of 1996 (P.L. 104-188) clarified the tax
treatment of qualified state tuition programs (including prepaid tuition contracts); it
generally provided that account earnings are to be included in designated
beneficiaries’ gross income only in the years when they receive distributions to attend
school. The Taxpayer Relief Act expanded the definition of qualified higher education
expenses for these programs to include reasonable costs for room and board in the
case of students attending at least half-time. (As under prior law, qualified expenses
also include tuition, fees, books, supplies, and equipment required for enrollment or
attendance.) Among other changes, the Act also expanded the definition of eligible
institution to include all Title IV HEA institutions. The former change is effective as
if it had been included in the Small Business job Protection Act; the latter change is
effective beginning January 1, 1998.
IRA Early Withdrawal Penalty
The Taxpayer Relief Act exempted IRA distributions used for qualified higher
education expenses from the early withdrawal penalty, beginning in January 1, 1998.
(The penalty otherwise applies to IRA distributions before age 59½, with a number
of exceptions. It equals 10% of the amount of the distribution that is included in
gross income.) Qualified higher education expenses include tuition, fees, books,
supplies, and equipment required for enrollment or attendance at Title IV HEA
institutions, plus (in the case of students attending at least half-time) reasonable costs
for room and board. The education must be for the taxpayer or the taxpayer’s spouse
or child (including stepchildren), or for a grandchild of the taxpayer or of the
taxpayer’s spouse.
Interest Deduction
The Taxpayer Relief Act authorized a new deduction for interest payments on
qualified education loans, effective January 1, 1998. The deduction is taken in
calculating adjusted gross income (an “above-the-line” deduction) and so is not
restricted to taxpayers who itemize. The deduction is allowed only with respect to
interest paid during the first 60 months (whether or not consecutive) in which interest
payments are required; it is limited to $1,000 in 1998, $1,500 in 1999, $2,000 in
2000, and $2,500 in 2001 and thereafter. The maximum allowable deduction is
reduced for taxpayers with modified adjusted gross incomes over $40,000 ($60,000
For
4
example, if a $1,000 distribution consisted of $600 in contributions and $400 in
earnings and if qualified expenses were $750, then the amount excluded from gross income
would be $100 (that is, $400 times [750/1,000]).
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in the case of a joint return). T
5
axpayers are not eligible for the deduction if they can
be claimed as a dependent by another taxpayer.
Qualified education loans are any indebtedness incurred to pay qualified expenses
of taxpayers, their spouse, or their dependents at Title IV HEA institutions or at
institutions of higher education, hospitals, or health care facilities conducting
internship or residency programs leading to a certificate or degree.6 At the time the
debt is incurred, students must be enrolled (or accepted for enrollment) in a degree,
certificate, or other program leading to a recognized educational credential and must
carry at least one-half the normal full-time work load. Qualified expenses generally
equal the cost of attendance minus scholarships and other education payments
excluded from taxes.
Employer Education Assistance
The Taxpayer Relief Act extended the exclusion for employer education
assistance through May 31, 2000. The exclusion, in Section 127 of the Internal
Revenue Code, allows tuition reimbursements and other forms of employer education
assistance to be exempt from taxes of the recipient even if the education does not
qualify as a deductible business expense. Qualifying education is not restricted to
Title IV HEA schools. The extension does not apply to graduate-level courses.7
Student Loan Forgiveness
The Taxpayer Relief Act expanded the tax exclusion allowed student loans that
are forgiven (in whole or in part) to include loans made by tax-exempt educational
institutions (for example, private colleges) even if the funds originated from a private,
nongovernmental source. As under prior law, the exclusion applies only if th
8
e
borrower works for a certain period of time in certain professions for any of a broad
class of employers (for example, teaches in an inner-city school). There is an
additional requirement for loans made by tax-exempt educational institutions from
private nongovernmental sources: the loans must be issued pursuant to a program
designed to encourage students to work in an occupation or area with unmet needs
and provide services either for or under the direction of a tax-exempt charitable
organization of governmental entity. The provision is effective for loan forgiveness
after August 5, 1997.
5Indexed for inflation after 2002.
6Qualified loans include indebtedness to refinance qualified education loans.
For
7
additional information, see CRS Report 97-243, Employer Education Assistance:
Overview of Tax Status in 1997, by Bob Lyke.
8The provision also extends the exclusion to refinancing loans issued by tax-exempt
entities, provided the requirement about working in an area or occupation with unmet needs
is met.
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Contributions of Computer Technology and Equipment
The Taxpayer Relief Act authorized an enhanced deduction for contributions of
computer technology and equipment to elementary and secondary schools or to tax-
exempt charitable organizations supporting elementary and secondary education.
Contributions to these entities may be made through a private foundation. The
property must be donated within two years after it was acquired or constructed, and
it must be originally used by either the donor or the donee. The enhanced deduction,
like others allowed under prior law, is limited to certain corporations; it is equal to the
fair market value of the contributed property minus 50% of the ordinary income that
would have been recognized had the property been sold for its fair market value.
(Without this exception, the deduction would equal the corporation’s basis in the
property, which usually is less.) However, the enhanced deduction is limited to twice
the basis of the property. The provision is effective for taxable years beginning after
December 31, 1997 and before January 1, 2000 (or before January 1, 2001 according
to the conference report).
Bonds
The Taxpayer Relief Act authorized tax credits for a new form of obligation
called qualified zone academy bonds. Qua
9
lified zone academies are public schools
and programs that provide education and training below the postsecondary level; they
must be designed in cooperation with business to enhance the academic curriculum,
increase graduation and employment rates, and better prepare students for college and
the workforce. The academies must either be located in empowerment zones or
enterprise communities or have 35% or more of their students eligible for free o
10
r
reduced price lunches. State and local governments may issue qualified zone academy
bonds only in 1998 and 1999, subject to a national limitation of $400 million each year
that is allocated proportionally to their share of the population in poverty. At least
95% of bond proceeds must be used for rehabilitating or repairing public school
facilities, providing equipment, developing course materials, or training teachers and
other school personnel. Private entities must contribute equipment, technical
assistance, employee services, educational opportunities, and other property worth
at least 10% of bond proceeds.
Qualified zone academy bonds are not tax-exempt; however, bondholders are
allowed a nonrefundable tax credit based upon a credit rate that the Secretary of the
Treasury determines would allow bonds to be issued without discount or interest cost
to the issuer. Thus, unlike tax-exempt bonds, the federal government will pay all the
interest costs. Qualified zone academy bondholders are limited to banks, insurance
companies, and corporations actively engaged in the business of lending money.
9For additional information and analysis of qualified zone academy bonds, see CRS
Report 97-828, Tax-Exempt Bond Provisions of the Taxpayer Relief Act of 1997, by Dennis
Zimmerman.
Empowerment
10
zones and enterprise communities are economically distressed areas that
qualify for special tax incentives and other federal assistance under P.L. 103-66. See CRS
Report 97-257, Empowerment Zones/Enterprise Communities Program: Background and
Analysis of Economic Issues, by Bruce Mulock.
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The Taxpayer Relief Act also repealed the $150 million ceiling on the total
amount of tax-exempt bonds that can be issued by a 501(c)(3) nonprofit organization,
which include private universities. The repeal applies to bonds issued after August
5, 1997. In addition, the Act expands the arbitrage rebate exception allowed
smaller issuers of governmental bonds. The general rule is that governmental units
that do not issue more than $5 million annually in governmental bonds do not have
to refund arbitrage earnings to the federal government. The Act provides that up to
$5 million annually in school construction bonds issued after 1997 need not be
counted for purposes of the $5 million ceiling.
Provisions not included in Act
The Taxpayer Relief Act did not include several education provisions that had
been in the House bill (H.R. 2014) when it was first passed. One would have
terminated the exclusion for qualified tuition reductions given employees (including
graduate teaching assistants) of educational institutions; a second would have
authorized a 50% nonrefundable credit (limited to $150) for amounts families paid for
supplementary elementary and secondary education services.
Similarly, several provisions that had been in the Senate bill (S. 949) were not
included: one would have allowed elementary and secondary school teachers who
itemize deductions to deduct professional development expenses without regard to
the 2% adjusted gross income floor; a second would have allowed tax-free
withdrawals from education IRAs for elementary and secondary school expenses.11
The
11
latter provision was introduced as an amendment by Senator Coverdell; it has been
reintroduced as separate legislation in both the House and Senate. For details, see CRS
Report 97-852, Education Savings Accounts for Elementary and Secondary Education, by
Bob Lyke.