WHAT THE “TAX CUTS AND JOBS ACT” MEANS FOR STUDENTS: DO WE WANT INCENTIVES OR SIMPLIFICATION?
By: Melanie Pulles Benson, Volume 102 Staff Member
The new House tax reform bill, the “Tax Cuts and Jobs Act” (“Act”), significantly departs from the current tax code. The Act alters the tax brackets, lowers the corporate tax rate by 15 percent, and eliminates the majority of current deductions and credits. The main goals of the Act are to simplify the tax code to enable the average taxpayer to better understand their tax liability, achieve better compliance at lower cost, and reduce the tax bill for the average family. The overarching goal of the tax code proposal is economic growth.
The Act fails to account for the incentives currently built into the current tax code. For example, the current code provides tax relief for education expenses in an attempt to incentivize higher education. The Act eliminates almost all of those education tax benefits and the incentives intended by those benefits. The Act would harm not only current students who now depend on those tax benefits, but would also harm future students.
This Post briefly discusses current education benefits and how they incentivize students. It explains how these benefits would change under the proposed revision, and the consequences of the proposed reform for students. The Post then further details the motivations for those changes. The Post concludes that the proposed tax simplification should be altered to preserve these benefits.
I. CURRENT TAX BENEFITS FOR EDUCATION EXPENSES
The current code has a variety of tax benefits for students and education in the form of deductions, credits, and exemptions. The overall purpose of these tax benefits is to encourage individuals to pursue education despite the high cost of attending college or graduate school. First, there are two deductions that benefit students: the deduction for tuition and the student loan interest deduction. Both of these deductions are “above-the-line,” meaning that students who claim the standard deduction, rather than itemizing, can still take advantage of them. This is important because most students do not have enough deductions to make it advantageous to itemize, meaning almost all take the standard deduction. The maximum deduction for qualified education expenses is $4000, provided the prescribed income level is not exceeded, but it may not be taken if the taxpayer takes advantage of any of the education credits available. Most likely, if a student is able to take an education credit, they will take that credit over the deduction because tax credits are generally more beneficial than deductions. The deduction for student loan interest paid on a student loan is $2500 per year, provided the specified income limits are not exceeded.
The current code also provides education credits, most importantly the American Opportunity Tax Credit (“AOTC”) and the Lifetime Learning Credit (“LLC”). The AOTC is significant for students because it is a refundable credit, payable to the taxpayer even if it exceeds taxes due. The credit is for up to $2500 of qualified education expenses paid throughout the year. The AOTC is only available for the first four years of post-secondary education. Additionally, the credit is not available if the taxpayer is a dependent. The LLC is significant for graduate students or students who are in school longer than four years. The LLC is a non-refundable credit for up to $2000, but it is available for every year of education after the first four years.
The current code also exempts certain education benefits from a taxpayer’s income. This includes the exclusion of scholarships, employer tuition reimbursement, and tuition waivers. This is a significant benefit because it reduces the overall tax liability that may be assessed, as the taxpayer has a lower income subject to taxation.
Finally, the tax code provides for tax benefits based on education savings programs. Essentially, parents or students can contribute to savings accounts or programs and list the student as the beneficiary. When the student takes money out of the accounts to pay for qualified education expenses, the funds are generally not taxable for the student as long as the funds are less than the qualified education expenses.
Critics have often called for reform of the tax benefits for education. Some have argued that the tax benefits are too confusing for the average taxpayer to decipher, which can lead to high costs in tax preparation services or the taxpayers failing to take advantage of the benefits. It has also been argued that the tax benefits do not actually incentivize students to pursue further education.
II. PROPOSED CHANGES TO THE EDUCATION TAX BENEFITS
The Republican tax provision would eliminate or alter the majority of these educational tax benefits. What would remain is a revised version of the AOTC and parts of the educational savings programs. Significantly, with the elimination of the LLC, education credits would no longer be available past the fifth year of higher education. The deduction for student loan interest would also be eliminated. In addition, students who have their tuition waived by their educational institution would now have to include that tuition as income on their tax return.
III. CONSEQUENCES OF THE PROPOSED CHANGES
The Republican sponsors defend the Act’s modification and combination of the education tax credits by saying that the change “will continue to serve to make college more affordable, while also streamlining these tax provisions so that they are easier for families to apply.” However, the modified AOTC does little to aid and incentivize students. First, in general, only wealthier taxpayers take advantage of the tax credit. Second, the taxpayer can only take advantage of the credit for five years. Eliminating the LLC impacts graduate students and non-traditional students who will be in school longer than five years. The credits as revised may be insufficient to provide meaningful assistance to existing students, and are likely not enough to encourage students to pursue higher education.
Some of the changes, such as the loss of the LLC and the student loan interest deduction, could be ameliorated with the Act’s proposed increase in the standard deduction. However, the change in tuition waiver taxable status is extreme for students and cannot be balanced by the proposed standard deduction, especially in combination with the elimination of the loan interest deduction, the elimination of the LLC unlimited application, and the elimination of the personal exemption. This taxable income change has created the most backlash for the bill because it significantly increases the tax liability for graduate students who do not have the income to pay it. Theoretically, this tuition waiver is considered a benefit to the student as a part of their compensation plan, and it should accordingly be taxed under an equitable tax system. However, this “income” never touches the students’ bank accounts or their hands. They are not able to save some of that income to pay for the resulting tax liability in the same way that an employer or an employee treats normal income. The result is a graduate student who makes around $30,000 a year having to pay tax on a “phantom income” of $80,000 a year.
IV. MOTIVATIONS FOR THE PROPOSED CHANGES
In the House Report that accompanied the bill, the explanation for the majority of these eliminations or modifications, other than the credits and savings plans, is boilerplate language that does not adequately explain the changes:
“The Committee believes that the repeal of many existing tax incentives, including the exclusion for qualified tuition reductions, makes the system simpler and fairer for all families and individuals, and allows for lower tax rates. The Committee further believes that repeal of this provision is consistent with streamlining the tax code, broadening the tax base, lowering rates, and growing the economy.”
Most would agree that some sort of tax reform is warranted because the current tax code is very complicated and long, with numerous exceptions, specifications, and details. For example, the definition of a qualified education expense can vary greatly across all of the educational tax benefit options. This inconsistency requires an analysis of what all should be included for the credit calculation, which in turn requires longer and more expensive tax preparation services. The tax code should be simplified. The important question when simplifying the code is what provisions should be eliminated and what provisions should remain.
The House Report explains that charitable contribution deductions get to stay because “a robust charitable sector is vital to our economy, and that charitable giving is critical to ensuring that sector thrives. For this reason, the Committee believes that it is desirable to provide additional incentives for taxpayers to provide monetary and volunteer support to charities.” Thus, unlike charitable deductions, continuing to provide tax incentives for education would not be as beneficial as simplifying the overall tax code, hence their repeal or modification. The behavior the benefits incentivize—pursuing school—is not achieved to a high enough degree to justify leaving the benefits in the tax code at the peril of simplification. What proponents of the Act have not considered, and what has been voiced as a criticism of the bill, is that education furthers the goal of economic growth. Higher education drives economic growth in many direct and indirect ways. Simply put, the more educated the workforce, the more profitable the company. Eliminating educational tax incentives could harm the goal of economic growth, even if the elimination may further the goal of simplification.
Although a lot of people would disagree with this justification for eliminating the tax benefits, the solution would be defensible if that were really the reason why the House proposes to make these changes. However, perhaps in addition to the simplification rationale, it can be argued that the House specifically made the tuition waiver taxable income and eliminated other tax-reducing benefits to compensate for the loss in revenue the other changes proposed to the tax code would create. The Act would reduce the tax on corporations from 35 percent to 20 percent. Regardless of the justifications for this corporate change, the fact remains that when income for the government is reduced, and expenses remain the same, the existing deficit of the country will continue to rise.
If one goal is to reduce that deficit as much as possible, logic dictates that the government would need a new source of revenue to compensate for the lost revenue from reducing the corporate tax rate. Hence, the House created the taxable tuition waiver under the proposed Act to help make up for lost revenue. Although this additional income is not enough to make up for the loss from corporations, it is still revenue. The House Ways and Means Committee contemplated this problem and general solution when it considered tax reform in 2015. One of the panelists, whose suggested tax reforms in 2015 appear throughout the Act, including the lower corporate tax, stated, “I think we all want to simplify the number of itemized deductions and loopholes in the Tax Code, but we ought to use those savings to lower tax rates across the board.” Those who support a majority of the changes in the Act contemplated making up for the lowered revenue from reducing the corporate tax by eliminating tax benefits, including education tax benefits (although referred to as government “savings”), with the overall goal of stimulating businesses and economic growth.
This brief analysis of education tax benefits is just a small part of the proposed tax reform. Simplification of the tax code is warranted and beneficial. Still, the tax code needs to serve other purposes—like incentivizing and helping students afford higher education. Congress should not abandon existing credits, deduction, and exemptions without meaningful compensations elsewhere in the code. The proper way to structure tax benefits for students is debatable, but the Tax Cuts and Jobs Act, which eliminates important benefits and maintains questionably effective benefits, is not an adequate solution.
- Tax Cuts and Jobs Act, H.R. 1, 115th Cong. (2017) (as passed by House, Nov. 16, 2017). ↑
- Id. at § 3001 (“Reduction in Corporate Tax Rate”), §§ 1101–1602 (Tax Reform for Individuals, Subtitles B–G). ↑
- H.R. Rep. No. 115-409, at 112 (2017). ↑
- Id. ↑
- See Sean Stegmaier, Tax Incentives for Higher Education in the Internal Revenue Code: Education Tax Expenditure Reform and the Inclusion of Refundable Tax Credits, 37 Sw. U. L. Rev. 135, 137 (2008) (discussing educational tax benefits as incentivizing higher education). ↑
- H.R. Rep. No. 115-409, at 147–62 (2017) (providing an explanation of the current law of the educational benefits, the effect of the current law, the proposed change, and an explanation of the proposed change). ↑
- See, e.g., Kaitlin Mulhere, College Students Set to Lose Several Big Tax Breaks Under GOP Tax Plan, Time (Nov. 2, 2017), http://time.com/money/5007540/gop-tax-plan-tax-breaks-college-students/ (discussing how the proposed tax changes will affect students, citing the American Association of State Colleges and Universities’ statement that “the tax plan will undermine public higher education through changes to tax breaks for students and families.”). ↑
- See Stegmaier, supra note 5. ↑
- Tax Benefits for Education: Information Center, IRS, https://www.irs.gov/newsroom/tax-benefits-for-education-information-center (last updated Oct. 18, 2017). ↑
- Id. ↑
- Cf. IRS, SOI Tax Stats- Individual Statistical Tables by Filing Status, Individual Income Tax Returns Filed and Sources of Income (2015), https://www.irs.gov/statistics/soi-tax-stats-individual-statistical-tables-by-filing-status – _grp1 (stating that roughly 30% of total filers in 2015 claimed itemized deductions). ↑
- Tax Benefits for Education: Information Center, supra note 9. ↑
- Tax Credits vs. Tax Deductions, U.S. Tax Center, https://www.irs.com/articles/tax-credits-vs-tax-deductions (last visited Nov. 21, 2017). ↑
- Tax Benefits for Education: Information Center, supra note 9. ↑
- American Opportunity Tax Credit: Questions and Answers, IRS, https://www.irs.gov/newsroom/american-opportunity-tax-credit-questions-and-answers (last updated Aug. 4, 2017). ↑
- Id. ↑
- Id. (noting the credit is for 100 percent of the first $2000, and 25 percent of the next $2000). ↑
- American Opportunity Tax Credit, IRS, https://www.irs.gov/credits-deductions/individuals/aotc (last updated Aug. 3, 2017) (noting common errors on the right hand side of the page, one of which is claiming the credit when you are a dependent). ↑
- Id. ↑
- Lifetime Learning Credit, IRS, https://www.irs.gov/credits-deductions/individuals/llc (last updated Aug. 11, 2017). ↑
- Tax Benefits for Education: Information Center, supra note 9. ↑
- Id. ↑
- See, e.g., Amy Oliver, Improving the Tax Code to Provide Meaningful and Effective Tax Incentives for Higher Education, 12 U. Fla. J.L. & Pub. Pol’y 91, 94 (2000) (discussing the need for more effective tax incentives for higher education); Camilla Watson, Reforming the Tax Incentives for Higher Education, 36 Va. Tax Rev. 83, 83 (2017); cf. Chris Edwards, Our Complex Tax Code Is Crippling America, Time (Apr. 11, 2016), http://time.com/4286921/complex-tax-code/ (discussing the current complexity of our tax code in general). ↑
- See Mulhere, supra note 7 (“Republicans say this plan will ‘streamline’ education benefits for families, and that’s a net positive. The current benefits are ‘so complicated that they are ineffective because many taxpayers cannot determine the tax benefits for which they are eligible’ it reads.”). ↑
- See Watson, supra note 23, at 86 (“Many of these proposals [to reform federal spending on higher education] focus on education tax incentives because they are low-hanging fruit; virtually everyone agrees that these incentives collectively do not work well.”). ↑
- H.R. Rep. No. 115-409, at 147–62 (2017). ↑
- Id. ↑
- Id. at 147–48. ↑
- Id. at 154–55. ↑
- Id. at 158. ↑
- Id. at 148. Another change that is not discussed in this post is the proposed tax on endowment funds. This is an important factor that may alter affordability of higher education for students, but the analysis of that change is outside the scope of this post. ↑
- See Danielle Douglas-Gabriel, Tax Credits Are a Bad Way to Help Families Pay for College. Here’s Why., Wash. Post (Apr. 10, 2015), https://www.washingtonpost.com/news/wonk/wp/2015/04/10/tax-credits-are-a-bad-way-to-help-families-pay-for-college-heres-why/?tid=a_inl&utm_term=.afdea1e93bcb (discussing how education credits have not worked in the past to incentivize education, especially for low-income families who do not owe enough in taxes to take advantage of the credit). ↑
- Id.; see also Watson, supra note 23, at 93–94. ↑
- See Mulhere, supra note 7 (“The maximum benefit from the student loan interest deduction is $625, and the average benefit is just $202.”). Although, this has to be weighed against other factors, including the elimination of the personal exemption. ↑
- See Chris Arnold & Emily Sullivan, Massive Tax Hike Under House GOP Plan, NPR (Nov. 14, 2017), https://www.npr.org/2017/11/14/563879136/house-gop-tax-plan-would-hit-grad-students-with-massive-tax-hike. ↑
- See, e.g., id; Erin Rousseau, The House Just Voted to Bankrupt Graduate Students, N.Y. Times (Nov. 16, 2017), https://www.nytimes.com/2017/11/16/opinion/house-tax-bill-graduate-students.html. ↑
- See Mary Grace B. Hebert, Everyone Should Care About Graduate Student Tuition Waivers, Inside Higher Ed (Nov. 16, 2017), https://www.insidehighered.com/views/2017/11/16/exempting-tuition-waivers-graduate-students-helps-all-society-essay (“Many graduate student employees receive tuition waivers as part of their compensation package.”). ↑
- Colleen Flaherty, ‘Taxing a Coupon,’ Inside Higher Ed (Nov. 7, 2017), https://www.insidehighered.com/news/2017/11/07/grad-students-and-policy-experts-say-taxing-graduate-students-tuition-waivers-would (“[A graduate student] never sees the tuition dollars that are waived, of course, so [the student would] have to pay taxes on them with the stipend checks she receives for her [work]. . . [the student] likened it to ‘taxing a coupon.’”). ↑
- See Arnold & Sullivan, supra note 35 (discussing that because a graduate student is paid $30,000 and has $50,000 of tuition waived, the student would have to pay tax on the total $80,000). ↑
- H.R. Rep. No. 115-409, at 158 (2017). ↑
- For a brief discussion of the complexity of the tax code, see Chris Edwards, supra note 23. ↑
- See Tax Benefits for Education: Information Center, supra note 8 (listing the various education benefits with specific definitions of a qualified tuition expense). ↑
- H.R. Rep. No. 115-409, at 177 (2012). ↑
- See Watson, supra note 23, at 117 (“A more educated populace not only would strengthen the national economy, but it also would make the United States more competitive in the global market.”); Arnold & Sullivan, supra note 35 (“Kim Rueben, a senior fellow in the Urban-Brookings Tax Policy Center at the Urban Institute, said the plan wouldn’t harm just grad students. If young people opt out of graduate education, the damage would be felt throughout the economy.”). ↑
- Cf. Amy Webb, A Tax Plan that Hurts Education Will Hurt U.S. Competitiveness, Harvard Business Review (Dec. 01, 2017), https://hbr.org/2017/12/a-tax-plan-that-hurts-education-will-hurt-u-s-competitiveness (“An educated electorate results in a strong, resilient, creative workforce. A country full of educated citizens innovates, solves challenges, gives rise to new businesses, supports new jobs, makes the economy strong, and creates the creature comforts we all want.”). ↑
- But see Watson, supra note 23, at 84 (“Today, the federal government spends over $180 billion on higher education, of which. . . around $34 billion is spent indirectly through foregone revenue attributable to the tax incentives.”); id. at 141 n.7 (“The largest of these tax expenditures (around $15.6 billion) is attributable to the American Opportunity Tax Credit.”). ↑
- Critics of the proposal agree. See, e.g., Erica L. Green, House G.O.P. Tax Writers Take Aim at College Tuition Benefits, N.Y. Times (Nov. 15, 2017), https://www.nytimes.com/2017/11/15/us/politics/house-tax-bill-higher-education-increases-tuition.html (quoting the American Council on Education’s statement that “Congress is sending a clear message that they’d rather use that money for corporate tax breaks.”). ↑
- Tax Cuts and Jobs Act, H.R. 1, 115th Cong. § 3001 (2017). ↑
- Id. ↑
- See supra note 46. ↑
- Perspectives on the Need for Tax Reform: Hearing Before the Subcomm. on Tax Policy of the H. Comm. on Ways and Means, 114th Cong. 23–24 (2016) (statement of Scott Hodge, President, Tax Foundation). ↑
- Id. ↑
- It has been argued that the academic institution can cure the problems associated with the taxability of tuition waivers. The institution can simply characterize the waiver as a scholarship to maintain its tax-exempt status. Preston Cooper, No, The House Tax Bill Won’t Destroy Graduate Education, Forbes (Nov. 20, 2017), https://www.forbes.com/sites/prestoncooper2/2017/11/20/no-the-house-tax-bill-wont-destroy-graduate-education/ – 1d5848984876–. Although this would theoretically solve the problem associated with the new bill, it is not clear how feasible this option would be. ↑