Tax-Favored Higher Education Savings Benefits and Their Relationship to Traditional Federal Student Aid Page: 4 of 23
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Tax-Favored Higher Education Savings Benefits and Their Relationship to Traditional
Policymakers have been concerned that a college education is becoming less affordable for
middle-income families because the rise in tuition has outpaced the increase in average
household income for the past two decades.' As a reflection of the desire among Members
of Congress to keep postsecondary education broadly available to the U.S. population, the
Congress has passed and enhanced a variety of tax benefits toward that end since 1990.
This report examines three tax-favored savings incentives for higher education, namely,
Coverdell Education Savings Accounts, Section 529 or Qualified Tuition Programs, and
Education Savings Bonds. It omits discussion of some other forms of tax-advantaged savings that
were created primarily for other purposes (e.g., Individual Retirement Accounts)2 and for which
higher education is just one of many possible uses (e.g., Uniform Gift or Transfers to Minors
Accounts).3 It then explains the interaction between the three postsecondary education tax
benefits and the process of determining student eligibility for traditional federal financial aid,
consisting of grants, loans, or work-study income.
The federal income tax measures specifically intended to assist individuals meet higher education
costs may be categorized in two ways: (1) those provisions intended to encourage taxpayers to
save for future postsecondary education expenses, and (2) those provisions meant to help
taxpayers meet current postsecondary education expenses. The first group is composed of
Education Savings Bonds, Section 529 or Qualified Tuition Programs, and Coverdell Education
Savings Accounts (formerly known as Education IRAs). To take advantage of these incentives,
taxpayers must be financially able to set aside money from current income for educational costs
they or others (e.g., their children) may incur in years to come. The second group includes the
Hope Scholarship Credit, the Lifetime Learning Credit, and the Higher Education Deduction.4
All education tax benefits share two characteristics. First, individuals must have a federal income
tax liability for the measures to be of value to them. Second, these provisions, like others in the
Internal Revenue Code (IRC), are paid for through revenue losses to the government rather than
through appropriations by the government.
The IRC sets forth how the tax incentives dedicated to assisting individuals finance a
postsecondary education are coordinated with one another. They interact not only with each other,
but also with the traditional student aid system. That is to say, the use of these tax provisions may
affect the government's calculation of student eligibility for need-based federal financial
1 For more information see CRS Report RL34224, College Costs and Prices: Issues for Reauthorization of the Higher
Education Act, by Rebecca R. Skinner and Blake Alan Naughton.
2 Funds withdrawn from an Individual Retirement Account (IRA) to pay for qualified higher education expenses are
exempt from the 10% tax penalty on distributions taken before age 59 . The earnings portion of withdrawals remains
subject to taxation. The IRA's owner must be the student, their spouse, or either of their children or grandchildren.
3 These accounts are irrevocable gifts to minors. Parents typically act as custodians of the accounts. The custodians
control the accounts until minors reach age 18 or 21, depending upon the state. The beneficiaries then can use the funds
for any purpose. Custodial accounts, which are subject to taxation annually, allow families to minimize their tax bills.
4 For information on these measures, see CRS Report RL31129, Higher Education Tax Credits and Deduction: An
Overview of the Benefits and Their Relationship to Traditional Student Aid, by Linda Levine and Charmaine Mercer.
Other higher education tax benefits that are not broadly available are not addressed in this report (e.g., employer
educational assistance and the miscellaneous business expense deduction).
Congressional Research Service
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Tax-Favored Higher Education Savings Benefits and Their Relationship to Traditional Federal Student Aid, report, January 18, 2008; Washington D.C.. (digital.library.unt.edu/ark:/67531/metadc805254/m1/4/: accessed December 16, 2018), University of North Texas Libraries, Digital Library, digital.library.unt.edu; crediting UNT Libraries Government Documents Department.