Federal assistance helps students and families pay for postsecondary education, but the complexity of tax preferences have caused some to overlook opportunities to reduce their tax liabilities, according to testimony submitted by the Government Accountability Office (GAO) to the U.S. House of Representatives Subcommittee on Select Revenue Measures.
In addition to being complex, the impact of education tax benefits on students and parents' ability to afford college remains relatively unknown, according to the GAO's testimony.
Since the 1990s, new federal initiatives to assist families and students in paying for postsecondary education have largely been implemented through the federal tax code. The federal tax code now contains a range of tax preferences that may be used to assist students and families in saving for, paying, or repaying the costs of postsecondary education.
These tax preferences include credits and deductions, both of which allow tax filers to use qualified higher education expenses to reduce their federal income tax liability. Tax credits reduce the tax filers' income tax liability on a dollar-for-dollar basis but are not refundable. Tax deductions permit qualified higher education expenses to be subtracted from income that would otherwise be taxable.
To benefit from a higher education tax credit or tuition deduction, a filer must use tax form 1040 or 1040A, have an adjusted gross income below the income limits specified in statute, and have a positive tax liability after other deductions and credits are calculated, among other requirements.
Difficulties with Tax Preferences
"Tax preferences require more responsibility on the part of students and families than Title IV aid because taxpayers must identify applicable tax preferences, understand complex rules concerning their use, and correctly calculate and claim credits or deductions," the GAO testified.
Although tax preferences is a newer policy tool, the number of tax filers using them has grown quickly; starting in 2002 their number has consistently surpassed the number of students aided under Title IV. Tax filers, however, do not appear to be making optimal education-related tax decisions.
According to analysis of a limited number of 2005 tax returns by the GAO, "Forty-one percent of eligible tax filers did not claim either the tuition deduction or a tax credit. In doing so, these tax filers failed to reduce their tax liability by $219, on average, and 10 percent of these filers could have reduced their tax liability by over $500."
Failure to claim available tax deductions or credits is most likely due to the complexity of postsecondary tax provisions. Experts have commonly identified the provisions as "difficult" for tax filers to use.
It is believed that simplifying federal grants, loans, and tax preferences may reduce complexities in higher education financing, including reducing the number of eligible tax filers that do not claim tax preferences. However, more research is necessary to understand the full benefits and costs of any such changes.
"Little is known about the effectiveness of Title IV aid or tax preferences in promoting, for example, postsecondary attendance or school choice, in part because of research data and methodological challenges," GAO testified. As a result, policymakers do not have information that would allow them to make the most efficient use of limited federal resources to help students and families.
How the Wrong Choice Affects Your Money
Poor choices among tax preferences for postsecondary education could be costly to tax filers. Mistakes in a tax preference could result in a lesser tax reduction.
"Families may strand assets in a tax-exempt savings vehicle and incur tax penalties on their distribution if their child chooses not to go to college," according to GAO testimony. "They may also fail to minimize their federal income tax liability by claiming a tax credit or deduction that yields less of a reduction in taxes than a different tax preference or by failing to claim any of their available tax preferences."
For example, if a married couple filing jointly with one dependent in his/her first 2 years of college had an adjusted gross income of $50,000, qualified expenses of $10,000 in 2007, and tax liability greater than $2,000, their tax liability would be reduced by $2,000 if they claimed the Lifetime Learning Credit but only $1,650 if they claimed the Hope Credit.
Still More to be Studied
Little is known about the effectiveness of federal grant and loan programs and education-related tax preferences in promoting attendance, choice, and the likelihood that students persist in their program-that is, either earn a degree or continue their education. Many federal aid programs and tax preferences have not been studied, and for those that have been studied, important aspects of their effectiveness remain unexamined. The GAO's 2005 report found no research on any aspect of effect of certain Title IV aid program or tax preferences on persistence.
For example, they found no research on the effects of federal postsecondary education tax credits on students' persistence in their studies or on the type of postsecondary institution they choose to attend, and they found limited research on the effectiveness of the Pell Grant program on students' persistence. One recently published study suggests that complexity in the federal grant and loan application processes may undermine its efficacy in promoting postsecondary attendance.
The relative newness of most of the tax preferences also presents challenges, because relevant data are just now becoming available.
"Proposals to simplify the federal financial assistance programs for postsecondary education may help to address the complexities in the current system and improve tax filers' use of education tax preferences," according to members of the House Select Revenue Measures Subcommittee. "However, more research is needed to understand the range of potential benefits and costs associated with any such changes. Congress has received little evidence concerning the effectiveness of assistance provided under Title IV or through tax preferences, including whether such assistance increases attendance or choice."
By Michael Jones II
NASFAA Communications Intern
Posted 05/30/08 to www.NASFAA.org. Redistribution to non-NASFAA institutions is prohibited. Please submit Web Site questions or comments to Web@NASFAA.org.
