Tax Credits for Individual Development Accounts

Tax Credits for Individual Development Accounts

Order Code RS21813
Updated February 8, 2006
CRS Report for Congress
Received through the CRS Web
Tax Credits for Individual
Development Accounts
Christine Scott
Specialist in Tax Economics
Domestic Social Policy Division
Summary
An individual development account (IDA) is a structured savings instrument for
lower income individuals. Currently, IDAs are associated with (1) state programs using
Temporary Aid to Needy Families (TANF) block grants; (2) a federal five-year
demonstration project established by the Assets for Independence Act (Title IV of P.L.
105-285); and (3) accounts established for refugees by the Office of Refugee
Resettlement. These IDA programs use government funds to encourage the
establishment of IDA programs and participation by qualified individuals and program
sponsors.
A new approach, that of using federal tax credits to encourage establishing and
funding IDA programs, was a component of legislation introduced in the 108th Congress
(Savings for Working Families Act of 2003). In the 109th Congress, legislation (S. 6,
S. 922, and S. 1780) has been introduced to establish IDA programs utilizing tax
benefits to encourage program development. This report will be updated as warranted
by legislative activity.
Current (Government Funded) IDA Programs
There are three current forms of individual development account (IDA) programs,
all of which are funded by federal, state, or local governments.1 Based on the funding
mechanism and statutory authority for the program, the three types of programs are as
follows.
Temporary Aid to Needy Families Programs. The 1996 welfare reform law
(P.L. 104-193) allowed states to use funds from the Temporary Aid to Needy Families
(TANF) block grant for IDAs for TANF-eligible persons. States may establish IDA
1 For more information on federal IDA grant programs, see CRS Report RS22185, Individual
Development Accounts (IDAs): Background and Current Legislation for Federal Grant
Programs to Help Low-Income Families Save, by Gene Falk.
Congressional Research Service ˜ The Library of Congress

CRS-2
programs and match funds deposited by IDA participants. States may also pay
administrative costs for the IDA program in addition to, or in lieu of, matching IDA
deposits.
Federal Demonstration Programs. The Assets for Independence Act (AIA,
Title IV of P.L. 105-285) authorized a five-year demonstration program, begun in 1999,
for IDAs. Federal funds are provided directly to nonprofit community groups, state and
local governments, or certain financial institutions to establish IDA programs. Federal
funds are used to match contributions made by program participants. Program sponsors
that match contributions by program participants as part of the demonstration program,
must have secured funding for all of the match before receiving federal funds.
Refugee Programs. The Office of Refugee Resettlement (ORR) uses agency
funds to establish and maintain IDAs for refugees, including a match of contributions by
program participants.
For each of these forms of IDA programs, government funds are used to match
participant contributions. For state programs associated with TANF, states may use part
of the federal TANF block grant, for the federal demonstration program discretionary
federal funds are used, and for the refugee program federal agency funds are used. For
some state programs associated with TANF, the state may also provide state tax credits
for contributors to the program.
For an IDA established under the federal demonstration program, there may be two
components: (1) a main account for the participant’s deposits and earnings on those
deposits; and (2) a parallel account maintained by the program’s financial partner
containing the matching contributions and earnings on the matching contributions.
Unlike the main account, the parallel account is not controlled by the program participant,
but by the IDA program and its financial partner.
Under current federal law for IDAs established under the federal demonstration
program, the parallel account funds, when distributed to third parties as a benefit to the
participant, are considered a gift and are not included in the income of the IDA program
participant. Because they are not included in the participant’s income, they are not
taxable. The interest earned on the main account (IDA deposits by the participant) is
taxable to the IDA participant.2
For tax-exempt program contributors there are no tax benefits associated with
making the matching contributions or providing any administrative assistance. Taxable
entities, such as financial institutions, may receive a tax deduction for matching
contributions and administrative or other assistance as charitable contributions, subject
to the limits on charitable contributions. Under current law, charitable contributions are
subject to annual limitations with excess contributions (above the limit) carried over to
future tax years.3
2 Internal Revenue Service, Revenue Ruling 99-44, Internal Revenue Bulletin No. 1999-44, Nov.
1, 1999.
3 For example, for individual in tax year 2005, total contributions are limited to 50% of adjusted
(continued...)

CRS-3
Using Federal Tax Credits to Fund IDA Programs
The funding structure for the current federal IDA demonstration program is based
on discretionary funds appropriated in the Department of Health and Human Services
annual budget. As a budget item, the federal IDA demonstration program is subject to
the annual budget process, and the possibility that the federal demonstration program is
partly funded or not funded at all. Similarly, the refugee program relies on the availability
of discretionary funds in the annual agency (ORR) budget, and IDA programs associated
with TANF rely on the availability of federal TANF block grants (including TANF
authorization). Any future federal IDA program that relies on direct federal funding also
would be subject to the federal budget process and the risk of a reduction or elimination
of funding.
A tax credit is a form of indirect government spending, a tax expenditure, and is
reflected in the budget as a reduction in revenues. Although a tax expenditure can be
reduced or eliminated, many think that a program funded by a tax expenditure is less
likely to be eliminated than a program funded through direct government spending. In
addition, many think that private entities, using tax benefits, can provide certain public
goods or services more efficiently, and at a lower cost, than the government.
One major issue with a switch from a budgeted program to a tax expenditure is
whether the tax expenditure would provide a benefit significant enough to continue a
program that was in the past directly funded by the government, or encourage expansion
of such a program. The impact of the incentive will depend upon a number of factors
including the tax status and general tax situation of the entity making IDA matching
contributions or administering IDAs. A nonrefundable tax credit will have no value to
a tax-exempt entity or a tax entity with no tax liability in a given tax year.
In the 109th Congress, legislation has been introduced (S. 6, S. 922, and S. 1780) that
would create an individual development account investment credit to encourage
participation and fund matching by private entities. In addition, the President’s FY2007
budget contains a proposal to establish IDAs and provide a tax credit for administrative
costs of maintaining the accounts and matching of funds deposited by account holders.
3 (...continued)
gross income. However, certain types of contributions may have a separate limitation of 20% or
30% of adjusted gross income. Excess contributions (above the limitations) may be carried over
for five tax years.