Proposed Simplification of Education Tax Breaks: The Good and the Bad

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With the cost of education climbing and more students graduating with record student loan debt, many college students and families unintentionally miss out on education tax breaks because of the complexity of tax-based student aid. In 2013, families with college students could benefit from the American Opportunity Credit (AOTC), the Lifetime Learning Credit, or the tuition and fees deduction. Eligibility for the three education benefits overlaps and families have to decide which incentive to claim for each student. According to the GAO, 14% of tax filers eligible for either the Lifetime Learning Credit or the tuition and fees deduction in 2009 failed to claim benefits and 40% of filers taking the tuition and fees deduction would have benefitted more from taking the Lifetime Learning Credit.

The House Ways and Means Committee recently approved legislation aimed at simplifying the many tax credits available for education. The bill would consolidate four existing education provisions: the Hope Credit, the American Opportunity Tax Credit, the Lifetime Learning Credit and the tuition and fees deduction into a single American Opportunity Tax Credit.

The new AOTC would be permanent and would provide a 100% tax credit for the first $2,000 of eligible higher education expenses and a 25% tax credit for the next $2,000 of expenses, for a maximum credit of $2,500. The first $1,500 of the credit would be refundable, meaning families could receive the credit regardless of whether they have federal income tax liability. The credit would be available for up to four years of post-secondary education at qualifying four-year universities, community colleges, and trade and vocational schools. The credit would phase out with incomes between $86,000 and $126,000 for married filing joint filers and half those amounts for single filers.

While all this sounds like good news, there are some not-so-favorable provisions to the legislation as well. The plan would eliminate the deduction for interest on student loans and the exclusion for employer-provided education assistance. The proposal also eliminates Coverdell educational saving accounts (but not the more popular 529 college savings plans), the exclusion for discharge of student loan indebtedness, the exclusion for tuition reductions by educational institutions to their employees, and the education expense exception to the penalty for early withdrawal from retirement accounts.

Also, since the AOTC would only be available to undergraduate students enrolled at least half-time in degree programs, graduate students and non-traditional learners would also lose tax benefits. The American Council on Education sent a letter to House Ways and Means Committee members indicating it will not support the proposed bill, as the improvements to the tax credits come at the expense of graduate and adult students.

By Janet Berry-Johnson, CPA