In the tax framework the GOP released in September, there was a passage that read, "The framework retains tax benefits that encourage work, higher education, and retirement security."
Now that an official tax reform bill, called the Tax Cuts and Jobs Act, has been introduced in Congress, there's been a lot of talk about the work- and retirement-related tax benefits, such as the lower tax rates on earned income and the preservation of the 401(k) deduction. However, few of the headlines have mentioned the many changes the bill makes to education tax benefits.
With that in mind, here's a rundown of seven key changes the Tax Cuts and Jobs Act makes to education tax benefits, some of which are positive for Americans and others of which may cost students more money.
1. The American Opportunity Credit can be used an extra year
There are currently three main tax benefits for Americans who pay tuition for themselves or someone else, the American Opportunity Tax Credit is by far the most lucrative: It can put up to $2,500 back in taxpayers' pockets.
Currently, the AOTC only available for the first four years of postsecondary education. Under the Tax Cuts and Jobs Act, the credit would be made available for five years of postsecondary education. That said, there are some limitations if a student elects to take the credit for a fifth year. According to the bill's summary, published by the Committee on Ways and Means, "The AOTC would also be available for a fifth year of post-secondary education at half the rate as the first four years, with up to $500 of such credit being refundable."
So a student claiming the credit for the fifth time would be eligible for a reduced credit amount of up to $1,250, with as much as $500 of this amount being refundable.
2. But the other tuition benefits would be repealed
The expansion of the American Opportunity Credit isn't simply meant to be a gift to college students. Rather, it's meant to consolidate the current education tax breaks into a single credit.
Specifically, the Tax Cuts and Jobs Act would repeal the Lifetime Learning Credit and the Hope Scholarship Credit. The Hope Scholarship Credit is typically less beneficial than the American Opportunity Credit. However, the Lifetime Learning Credit, which is worth up to $2,000 per year, does some things the American Opportunity Credit doesn't, notably:
- It can be used for an unlimited number of years.
- Students don't need to be enrolled in a degree or certificate program to claim it.
So this could be bad news for graduate students, people taking courses for professional enrichment, and students who take more than five years to complete their bachelor's degrees.
3. Coverdell ESAs could be going away
There are two main tax-advantaged ways Americans can save for college expenses: the 529 savings plan and the Coverdell Education Savings Account, or Coverdell ESA. Under the proposed tax bill, the Coverdell ESA could be eliminated.
Specifically, new contributions to Coverdell accounts would be prohibited after 2017. From a financial standpoint, this makes sense: Coverdell ESAs only allow for $2,000 in contributions per year, while 529 savings plans allow for many times this amount. The tax structure of the plans is the same, and many state-run 529 plans have additional tax incentives. So it certainly makes sense to consolidate the two into the higher-value account type in order to simplify the tax code.
4. 529 plans may not just be for college anymore
One of the main advantages of Coverdell ESAs is that they allow account holders to use the funds in the account for educational expenses at all levels -- not just college. The proposed tax bill would allow 529 funds to be used for elementary and high school expenses of up to $10,000 per year, which would compensate for the elimination of the Coverdell ESA as a savings option. Apprenticeship programs would also become a qualified expense for 529 plans.
5. Want to start saving for college before your child is born?
Under current law, you need a Social Security number to name a designated beneficiary for a 529 savings plan. Personally, I had to wait until a few weeks after my daughter was born before I had the information necessary to open an account.
The Tax Cuts and Jobs Act would allow unborn children to be treated as designated beneficiaries of 529 plans while they are "at any stage of development." In other words, as soon as you find out you're expecting, you could start a 529 savings plan for your child.
6. Student loan interest would no longer be deductible
Currently, individuals who qualify based on their income can deduct up to $2,500 of student loan interest per year. The Tax Cuts and Jobs Act would repeal this itemized deduction and many other tax deductions. To be fair, the Tax Cuts and Jobs Act would nearly double the standard deduction, which could compensate some of the millions of Americans who have student loans for the loss of this deduction -- but not all of them.
7. Other tax benefits would go away
The student loan interest deduction isn't the only education tax break that would disappear under the Tax Cuts and Jobs Act. Combined, these cuts are expected to save the federal government $47.5 billion over the next 10 years, helping to pay for massive tax cuts elsewhere.
Here are some other notable cuts to education-related tax breaks:
- The tuition and fees tax deduction (used if the taxpayer couldn't qualify for the education credits) would be repealed.
- Currently, U.S. savings bond interest used to pay for college is tax-free. This would no longer be the case.
- If a tuition reduction is provided by an educational institution to its employees, their spouses, or their dependents, this amount would be included in income.
- Under current law, up to $5,250 in employer-provided education assistance is excluded from income. This would be repealed.
The bottom line
The Tax Cuts and Jobs Act does preserve some valuable education tax benefits and consolidates certain programs, simplifying our tax code a little. However, it eliminates many tax deductions and exclusions that currently save many taxpayers thousands of dollars. So, while some people would welcome these changes -- especially those who want to use their 529 plans for a private high school -- others would see some of their most valuable tax breaks disappear.