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Education Sees Direct Hits in Proposed Tax Reform Bill

The proposed Congressional Tax Reform Act of 2014, put forward this week by Dave Camp, chair of the House Ways and Means Committee, would end deductions for tuition and student loan interest and eliminate certain deductions, such as classroom supplies purchased personally by teachers in an effort to simplify the tax code related to education. To soften the blow to education, promised the authors, taxpayers would see "more generous" standard deductions, which could offset specific ones no longer allowed.

An executive summary of the tax proposal complained that the current tax code "contains 15 different tax breaks for higher education," which takes a 94-page document to explain. "That isn't a tax code designed for working families; it is a tax code designed to make money for accountants," wrote Camp in an opinion piece in the Wall Street Journal.

The new proposal consolidates those 15 education provisions into five:

  • A permanent American Opportunity Tax Credit (AOTC);
  • A business deduction for work-related education expenses;
  • Exclusion of scholarships and grants;
  • Gift tax exclusion for tuition payments; and
  • Tax-free 529 savings plans.

The "reform" version of the AOTC blends four tax benefits — the Hope Scholarship Credit (HSC), Lifetime Learning Credit, tuition deduction, and the temporary AOTC — into one. That part of the tax reform was pulled together in a working group led by Reps. Diane Black (R-TN) and Danny Davis (D-IL).

The current AOTC and lifetime learning credits offset the cost of higher education by reducing a person's income tax. (A tax credit directly reduces the amount of tax paid whereas a deduction reduces the amount of income subject to tax.) The AOTC provides a 100-percent tax credit for the first $2,000 of certain higher education expenses (tuition, fees and course materials) and a 25-percent tax credit for the next $2,000 of such expenses, for a maximum credit of $2,500. After 2017, the AOTC expires and taxpayers may claim the HSC instead, which provides a smaller credit.

Under the new code, AOTC would provide a tax credit for the first $2,000 of certain higher education expenses (tuition, fees and course materials) and a 25 percent tax credit for the next $2,000 of expenses. Also like the current AOTC, it would be available for up to four years of higher education. However, the same provision would deem Pell Grants to be applied first against expenses not covered by the AOTC; currently, Pell grants have to be used against the same expenses covered by AOTC and HSC, an ordering that has confused taxpayers.

This set of provisions would kick in for tax years beginning after 2014.

The reform would also repeal the deduction for tuition and related expenses. Currently, the maximum amount of a deduction is $4,000 for taxpayers whose adjusted gross income doesn't exceed $65,000 — $130,000 on a joint return — and $2,000 for taxpayers whose adjusted gross income doesn't pass $80,000 — or $160,000 for a joint return. For tax years beginning after 2013, that deduction would go away.

Currently, Coverdell education savings accounts, which pay education expenses of a named beneficiary, are exempt from tax. The contributions into the accounts aren't deductible and can't be more than $2,000 per beneficiary annually. Nor can they be made once the recipient turns 18. Under reform, Coverdell accounts go away after 2014 but would allow tax-free rollovers into section 529 plans.

Under reform, those taxpayers with student loans that have been "forgiven" because they work in certain professions or for certain organizations will now have to pay taxes on that "discharge" of indebtedness. This provision would become active for amounts discharged after 2014.

Under current law, qualified tuition reductions provided by educational institutions to their staff members, employee spouses, and dependents are excluded from income. This exclusion would go away after 2014.

Similarly, employer-provided education assistance up to $5,250 per year also would be eliminated except in cases where the education is related to the employee's performance of his or her work.

For families who draw early from their Individual Retirement Accounts to cover the expense of higher education, the new code would enforce the same 10 percent tax penalty imposed on early withdrawal for non-education purposes. Currently, if the money is being used for education, that tax doesn't apply. The purpose here, according to the reform tax authors, is to encourage "taxpayers not to make withdrawals from their accounts before retirement."

Reform is also proposed for expenses related to the business of being an employee. Teachers who buy supplies for their classrooms out of their own pockets fall into this category. Currently, those expenses are allowed as "above-the-line deductions" as long as the expenses are itemized. Under the new provisions, starting in tax years after 2014, those deductions go away for almost everybody. (The exception is members of reserve military units.)

In explanation, the authors of the proposed new code said this provision was intended to "simplify the tax laws for taxpayers who currently claim deductions for employee business expenses," and eliminate the burden of keeping records.

Camp's public pitch on what could appear to be unpopular stances regarding long-assumed tax deductions focuses on that theme of simplifying the process of filing taxes. "Paired with more commonsense reforms like increasing the standard deduction and the child tax credit will mean that nearly 95 percent of the country can get the lowest possible tax rate by just filing the basic IRS 1040A form — no more itemizing, no more keeping track of all those receipts, and no more filling out all those extra schedules, forms and work sheets," he stated.

The 979-page document represents the output from three "discussion drafts," 11 separate bipartisan tax reform working groups and 14,000 public comments posted to TaxReform.gov.

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