Education: What tax incentives exist to help families pay for college?
Rapidly rising college expenses in the 1990s spurred the 1997 enactment of tax incentives for higher education which included the Hope Credit, the Lifetime Learning Credit (LLC), and a deduction for tuition and fees. Since then, the Hope has been temporarily supplanted by the more generous American Opportunity Tax Credit (AOTC) which was first enacted as part of the American Recovery and Reinvestment Tax Act of 2009 and extended through 2017 in the American Taxpayer Relief Act of 2012. The Tax Policy Center estimates that in 2013, 12.6 million students will receive $21.3 billion in assistance through the AOTC. An additional 2.6 million student will receive $1.7 billion in aid via the LLC, and the tuition and fees deduction will provide less than $1 billion in aid. Other tax incentives encourage families to save for college (see Taxation of the Family: What tax incentives exist to help families save for college?).
- The AOTC provides a tax credit of up to $2,500 per undergraduate student enrolled in the first four years of postsecondary school (up from the first two years allowed by the Hope). Students can receive a credit of 100 percent of the first $2,000 of tuition, fees, and books and a 25 percent credit for the next $2,000 of these same expenses (Hope expenses do not include books). Up to $1,000 of the AOTC is refundable (the Hope was not refundable). AOTC amounts are not indexed for inflation, though Hope amounts were. Under pre-ATRA law, in 2013 the Hope would’ve grown to a maximum credit of $1,950.
- The Lifetime Learning Credit equals 20 percent of tuition and fees for any post-secondary education expense, up to a maximum annual credit of $2,000 per tax unit. That maximum applies to the combined expenses of all students in the household claiming the credit and is reached when total qualifying expenses reach $10,000.
- The maximum benefit for the American Opportunity Tax Credit phases out between adjusted gross income $80,000 and $90,000 (between $160,000 and $180,000 for married couples). The maximum benefit for the Lifetime Learning Credit phases out between adjusted gross incomes of $45,000 and $55,000 for single taxpayers, or between $90,000 and $110,000 for married couples.
- Most people who qualify for a tax credit for education expenses will benefit more from the American Opportunity Tax Credit than the Lifetime Learning Credit by virtue of the AOTC being the larger of the two and the fact that it is partly refundable so available to taxpayers with no tax liability. Students who do not qualify for the AOTC – those who are less than half-time, are in their fifth year of school, or graduate students for example can benefit from the LLC.
- The deduction for tuition and fees allows taxpayers (parents or students, whichever pays) to reduce taxable income by up to $4,000. To qualify, a family’s adjusted gross income may not exceed $65,000 for single filers or $130,000 for married filers. Single filers with AGI between $65,000 and $80,000 or married filers with AGI between $130,000 and $160,000 can deduct up to $2,000 of expenses. After that, a family is no longer eligible for the deduction. The tuition and fees deduction is scheduled to expire after 2013.
- Whether a taxpayer will benefit more from the tuition and fees deduction or the lifetime learning credit, will depend on the expenses incurred, the taxpayers marginal tax rate, and the state the family lives in. (Some state income tax liabilities will be lowered by the tuition and fees deduction.)
- The AOTC, LLC and tuition and fees deduction are not available to taxpayers with filing status married filing separately.
- The Lifetime Learning Credit is nonrefundable, so only people who owe income tax can benefit. Similarly, the deduction for tuition and fees is valuable only for people with taxable income.
Before Congress created the AOTC, critics cited the likely minimal effect tax benefits had on college enrollment. Instead, tax subsidies provided benefits to people who were likely to attend college even without the additional aid. Many low-income students who might have been the most influenced by reduced college costs could receive little or no benefit from the Hope and LLC credits because they were nonrefundable and thus could only offset income taxes owed. Because the AOTC is refundable, lower-income families can receive the credit. In 2013, TPC estimates that 20 percent of benefits will go to students in families with adjusted gross income less than $30,000 [see Table 1]. Even so, students with incomes below $50,000 receive more aid from the Pell grant than from the tax credits. Even with the changes to the tax credits, it remainsunclear whether tax credits increase college enrollment.
Using the tax system to subsidize higher education has two primary advantages over using traditional spending programs: Students need not fill out the complicated Free Application for Federal Student Aid form to receive benefits and every student who qualifies receives the full benefit for which they appear entitled. However, there are also disadvantages to providing aid through the tax systems including the delay in funds being received (up to fifteen months after tuition was paid).
Possible options for reform
- Even though some books are now eligible expenses for the American Opportunity Tax Credit (as opposed to only tuition and fees for the Lifetime Learning Credit), additional assistance could be provided by broadening coverage to include more expenses such as room and board.
- Providing benefits directly to schools when students enroll (based on estimates of the previous year’s taxes) could help students cover college costs when they actually have to make payments, not months later when their families file tax returns.
Simplifying the credits into a single credit would make the process more transparent for students.