Education Savings Accounts for Elementary and Secondary Education

97-852 EPW
Updated June 19, 1998
CRS Report for Congress
Received through the CRS Web
Education Savings Accounts
for Elementary and Secondary Education
Bob Lyke
Specialist in Social Legislation
Education and Public Welfare Division
Summary
The Taxpayer Relief Act of 1997 (P.L. 105-34) that President Clinton signed on
August 5, 1997, authorized new education individual retirement accounts (education
IRAs) for higher education expenses. When the legislation was enacted, identical bills
were introduced in both the House (H.R. 2373) and Senate (S. 1133) to increase annual
contribution limits from $500 to $2,000 and allow accounts to be used for elementary
and secondary education expenses. The bills are similar to an amendment introduced by
Senator Coverdell that the Senate adopted during initial floor consideration of the
Taxpayer Relief Act. The amendment was not included in the conference agreement
because of a threatened veto by the President.
Legislation similar to these bills was approved by the House on October 23, 1997
(a modified version of H.R. 2646) and the Senate on April 23, 1998 (an amendment to
H.R. 2646). The June 10 conference agreement
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would increase the annual contribution
limit to $2,000 through the year 2002; thereafter, annual contributions would again be
limited to $500. The agreement would also make several technical amendments to
education IRAs and permit contributions and accounts to continue without age limit for
special needs students. In addition, it would expand other education tax incentives and
make other changes to federal education law. The House approved the conference
agreement on June 18 . The President has said he would veto it.
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The principal issue raised by these bills is whether the federal government should
support more family choice of elementary and secondary schools, both public and
private. Questions have also been raised about possible compliance problems and
whether the legislation would help lower income families.
Current Law
Current law provides a number of tax allowances for family higher education
expenses, including tax credits (the HOPE and Lifetime Learning credits), exclusions and
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deferrals to encourage saving (for Education IRAs, U.S. savings bonds, and state prepaid
tuition programs), a deduction for interest payments on student loans, and an exclusion for
employer education assistance. In contrast, there are no comparable tax allowances for
what families spend on elementary and secondary education: tuition, books, equipment,
activity fees, uniforms, transportation, and other costs. Congress has several times debated
elementary and secondary school tuition tax credits, but no legislation that would authorize
them has been reported from committee since 1983.1
Elementary and secondary education receives some indirect tax benefits. Public
schools benefit from the deduction of state and local taxes (limited to taxpayers who
itemize) and the exclusion of interest on school construction bonds. Public and private
schools both benefit from the deduction for charitable contributions (for taxpayers who
itemize and corporations). Private schools are tax-exempt, so their income is not subject
to taxation. Their scholarships are also not taxed. The sum of these indirect tax benefits
may be comparable to federal grants currently available for elementary and secondary
education.
Current Legislation
The legislation discussed in this report would amend the Education IRA provisions
of the Internal Revenue Code that were included in the Taxpayer Relief Act of 1997.2
These provisions authorize contributions of up to $500 a year to education investment
accounts for beneficiaries under age 18, beginning in 1998. The $500 limit is reduced for
taxpayers with modified adjusted gross incomes over $95,000 ($150,000 for joint returns).
Contributions are not deductible, but accounts are exempt from taxation and distributions
are excluded from beneficiaries’ gross income if used for higher education tuition, fees,
books, supplies, equipment, and certain room and board expenses. The exclusion cannot
be claimed the same year that either the HOPE or the Lifetime Learning credit is claimed
for the student. The conference report states that account balances will be deemed to be
distributed when the beneficiary reaches age 30.3
The “Parents and Students Savings Account PLUS Act” (H.R. 2373 and S. 1133,
introduced by Speaker Gingrich and Senator Coverdell, respectively) would raise the
annual contribution limit of Education IRAs to $2,000 and allow accounts to be used in any
proportion for elementary and secondary as well as higher education expenses. Qualifying
K-12 expenses would include “tuition, fees, tutoring, special needs services, books,
supplies, equipment, transportation, and supplementary expenses required for the
enrollment or attendance of the designated beneficiary of the trust at a public, private, or
sectarian school.” Homeschooling expenses would also qualify if that education met State
or local requirements.
1 For information about family higher education tax allowances, see CRS Report 97-915, Tax
Benefits for Education in the Taxpayer Relief Act of 1997
, by Bob Lyke.
New Code Section 530 established by Section 213 of the Act.
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3 The age limitation is not included in the statutory language of the Taxpayer Relief Act. The “Tax
Technical Corrections Act of 1997" (H.R. 2645) that the House Committee on Ways and Means
approved on October 9, 1997, would amend the statutory language to include it.

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House Legislation. H.R. 2646 (the “Education Savings Act for Public and Private
Schools”) is similar to H.R. 2373 and S. 1133, but it would allow contributions of up to
$2,500 a year. It would clarify that contributions may be made by corporations. (If
contributions were made to employees’ children’s accounts, they would be taxable to the
employees.) In addition, it would allow contributions for a special needs beneficiary (as
defined by Treasury Department regulations) to continue after the child turned 18.
Accounts for such children would not have to be terminated at age 30. The House Ways
and Means Committee approved H.R. 2646 on October 9, 1997, and the House passed it
on October 23, 1997, (with a provision restricting the increased annual contribution limit
to 5 years. Thus, after December 31, 2002, contributions to accounts would be limited to
$500 and could be used only for higher education expenses. To offset the revenue loss, the
House bill would prospectively overturn a Tax Court decision (Schmidt Baking Company,
Inc. v. Commissioner
) regarding deductions for accrued vacation and severance pay.
Senate Legislation. On February 10, 1998, the Senate Committee on Finance
approved S. 1133 (the “Parent and Student Savings Account PLUS Act”) with an
amendment in the nature of a substitute. As reported, the legislation would increase the
annual contribution limit to $2,000 for 5 years (subject to the same sunset provision as in
H.R. 2646) and also allow contributions for a special needs beneficiary to continue after
the child turned 18. Accounts for such children would not have to be terminated at age 30.
It too would clarify that corporations could make contributions. In addition, the reported
legislation would expand other education tax incentives: (1) it would allow an exclusion
for distributions from qualified state tuition programs (currently, distributions are partly
included in the gross income of the student); (2) it would expand the exclusion for
employer education assistance to include graduate-level courses and through 2002);4 (3)
it would increase the small issuer arbitrage rebate exception for tax-exempt bonds to $15
million, provided at least $10 million of the bonds are issued to finance public schools; and
(4) it would allow an exclusion for certain amounts received under the National Health
Corps scholarship program notwithstanding obligations of recipients to provide medical
services in the future. Two revenue loss offsets were included: one similar to the House
provision regarding accrued vacation pay (but not accrued severance pay) and another
changing the foreign tax credit carryover period.
The Senate had begun debating H.R. 2646 on October 29, 1997, but suspended
further consideration on November 4, 1997, after the failure of a second cloture motion.
Reconsideration resumed on March 13, 1998. On March 18 , the Senate adopte
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amendment number 2019 (introduced by Senator Roth) which incorporated S. 1133 as
reported; it also included a provision allowing tax exempt facility bonds to be used for
certain public school construction.5 On March 27 , there was a unanimous consen
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agreement to postpone further debate until April 20th.
During the week of April 20 , the Senate concluded debate on the legislation. I
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addition to the March 18 amendment, the Senate adopted amendments dealing wit
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federally sponsored testing, student improvement incentive awards, teacher testing and

4 For further information, see CRS Report 97-243, Employer Education Assistance: Overview of
Tax Status in 1998
, by Bob Lyke.

5 Amendment 2019 is printed in the Congressional Record for March 18, 1998, p. S2222-2224.

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merit pay, same gender schools and classrooms, block grants, programs to encourage
reading, dropout prevention, multilingualism, and safer schools.6
Conference Agreement. The conference committee on H.R. 2646 (renamed the
“Education Savings and School Excellence Act of 1998") announced its agreement on June
10, 1998. The agreement includes the following tax provisions, among others:
! it would increase the annual contribution limit from $500 to $2,000 beginning in
1999 and continuing through the year 2002;
! with respect to contributions made from 1999 through 2002 (and the earnings
thereon), it would allow tax-free distributions from Education IRAs for elementary
and secondary education, including private schools;
! it would clarify that income limits on contributors apply only to individuals, not
corporations or other entities;
! it would waive the age limits for contributions and continuation of accounts for
special needs students;
! it would exempt from taxation disbursements from qualified state tuition programs
that are used for qualified higher education expenses (currently, only amounts
attributable to contributions are excluded);
! it would allow private colleges to offer qualified tuition programs as well (with the
same tax treatment as state programs) beginning in 2006, though only for prepaid
tuition programs and only if contributions for a beneficiary do not exceed $5,000
annually or $50,000 in total;
! it would extend the exclusion for employer education assistance (Section 127) for
courses below the graduate level from May 31, 2000 to December 31, 2002;
! it would increase the small issuer arbitrage rebate exception for tax-exempt bonds
to $15 million, provided at least $10 million of the bonds are issued to finance public
schools;
! it would provide that National Health Corps Scholarships and F. Edward Herbert
Armed Forces Health Professions Scholarships would be eligible for tax-free
treatment under Section 117;
! it would overturn the Tax Court decision in Schmidt Baking Company, Inc. v.
Commissioner regarding deductions for accrued vacation and severance pay,
effective for taxable years ending after December 31, 2001.
6 For additional information on these issues, see CRS Report 97-774, National Tests:
Administration Initiative
, by Wayne Riddle; CRS Report 97-972, Reading Instruction: New
Federal Initiatives
, by Wayne Riddle; and CRS Issue Brief 98013, Elementary and Secondary
Education Block Grant Proposals in the 105th Congress
, by Wayne C. Riddle and Paul M. Irwin.

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In addition, the conference agreement adopted some non-revenue education measures.
The House approved the agreement on June 18 by a vote of 225 to 197. In a June 16
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letter, the President said that he would veto the legislation if Congress approved it.
Education Savings Account Issues
Extending Education IRAs to elementary and secondary education would demonstrate
greater federal commitment for school choice. Whether families should have more options
in selecting schools is a matter of increasing debate, particularly if sectarian and other
private schools are included. Proponents of choice argue that parents should be allowed
to choose schools for their children without losing public subsidies. Opponents maintain
that allowing greater choice would fragment the school age population and erode support
for public education. Conflicting concerns about the continuing problems of public schools
(particularly in inner cities), academic standards, racial integration, and constitutionality
complicate the issue.
7
The tax benefits of Education IRAs would grow slowly: $2,500 invested at 6% would
increase in 5 years to $3,089 if it were taxed (at 28%) and $3,346 if it were tax exempt, a
difference of $257. Even after 10 years, the difference
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would be only $661. Whether
tax savings of this magnitude would change enrollment decisions might be doubted; the
principal effect might be to subsidize families that would elect other schools anyway. Of
course, the tax savings would be greater if $2,500 were saved each year and no
withdrawals were made until the child were in high school. However, tax savings would
be smaller if a family’s marginal tax rate were 15% ($140 after 5 years and $366 after 10
years), and they would be nonexistent if the family did not have any tax liability or
otherwise were unable to save. Some of what families save on taxes would be offset if
schools increased fees in response to the legislation.
The proposed legislation raises several compliance questions. While payments
families make for tuition could easily be traced, what they spend for tutoring, books,
supplies, equipment, transportation, and supplementary expenses might not be. Receipts
might not have adequate documentation (or be kept), and they might not prove that only
the student benefitted. Documentation may be especially difficult for homeschooling.
Education expenses are not inherently difficult to trace, but procedures (possibly involving
schools) would be to be developed that ensure compliance without burdening either
families or the Internal Revenue Service.

7 For a discussion of issues regarding school choice, see CRS Report 95-344, Federal Support of
School Choice: Background and Options,
by Wayne C. Riddle and James B. Stedman.
8 In 1997, married couples filing joint returns are taxed at 15% on the first $41,200 of taxable
income and 28% on taxable income over $41,200 up through $99,600.