An Overview of Tax Benefits for Higher Education Expenses

Publication Date: January 2006

Publisher: Library of Congress. Congressional Research Service

Author(s):

Research Area: Education

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Abstract:

Government subsidies for education are available at the federal, state, and local levels. Governments employ two types of direct spending programs to help families pay for higher education: subsidies to public postsecondary institutions and needbased aid to students and families. The Higher Education Act (HEA; most recently extended by P.L. 109-150), which is scheduled to expire in the 109th Congress, authorizes many need-based student aid programs, which provide grants, loans, and work-study assistance. In addition to these direct spending programs, government subsidies for higher education are also made through the income tax system. CRS Report RL32507, Higher Education Tax Credits: An Economic Analysis, by Pamela J. Jackson, provides a discussion of the economic rationale for subsidizing higher education.

Tax benefits for higher education can be divided into three groups: incentives for current year higher education expenses, incentives that give preferential tax treatment of student loan expenses, and incentives for saving for college. This report discusses eight tax incentives that provide benefits to taxpayers for the expenditures they make on higher education in a given year. These provisions include two tax credits, the Hope Credit and the Lifetime Learning Credit; two deductions, an abovethe-line deduction for tuition and fees, and a deduction for work-related education; three exclusions for scholarship and fellowship income, tuition reductions, and employer-provided education benefits; and a personal exemption for student dependents age 19 to 23. Tax benefits for student loan expenses allow the deduction of interest paid on student loans and provide an exclusion for student loans that have been forgiven. Five types of tax incentives promote taxpayer saving for college expenses: 1) Section 529 plans, 2) Coverdell Education Savings Accounts, 3) an education savings bond program, 4) a provision which allows early withdrawals from individual retirement accounts (IRAs) without penalty, and 5) the allowance of uniform transfers to minors.

The recipients of benefits through the tax system can be quite different from the recipients of benefits provided through spending programs. First, because none of these provisions are available to families whose incomes are too low to pay income taxes, some low income individuals (including independent students) cannot benefit from them since none provide for refundability. Even those who pay income taxes may not receive the full benefit due to limited tax liability. By contrast, direct spending programs are often particularly directed toward lower income individuals who are more likely to attend (lower cost) public institutions and to qualify for needbased aid. This report provides an overview of the tax benefits for higher education, along with cost estimates of the revenue loss associated with these provisions.

The report concludes with a discussion of the beneficiaries of education tax incentives. This report will not be updated.