Tax reform legislation, the “Tax Cuts and Jobs Act,” moving through Congress would affect nearly every sector of the American economy, including higher education. Both the House and Senate bills would enact several changes to provisions in the tax code that currently provide billions of dollars per year in support to students and institutions.
Generally, tax expenditures serve as an alternative to direct spending programs, allowing the federal government to advance priorities by way of tax relief. The incentives come in the form of credits (which reduce tax liability), and deductions, exemptions, and exclusions (which shield certain income from taxation and therefore reduce taxable income). The federal government provides roughly $30 billion annually in higher education-related federal expenditures.
The House and Senate bills vary considerably in their proposed changes to the tax treatment of the higher education system, with the House version (in most instances) the more aggressive of the two.
Following are some highlights:
The current system includes two tax credits designed to defray college costs among low-income and middle-class students: the American Opportunity Tax Credit (AOTC), and the Lifetime Learning Credit (LLC). 1
These two credits provide around $20 billion annually in support to taxpayers pursuing a post-secondary education, and students may only claim one of the two. The AOTC is available for the first four years of a student’s post-secondary education. Students must be enrolled at least half-time, and the credit provides a maximum benefit of $2,500 as a reimbursement for tuition, fees and course materials, $1,000 of which is refundable (meaning it can be awarded to individuals with no tax liability). In contrast, the LLC offers up to $2,000 annually as a reimbursement for tuition and fees. Although it is not refundable, there is also no limit to the number of years that it can be claimed. This is beneficial for students who take more than four years to complete college, as well as for graduate students.
The House-passed legislation would condense these two credits into one—a new AOTC. This singular credit would offer a maximum of $2,500 for the first four years of a student’s post-secondary education and up to $1,250 for the fifth year. Tax credits would not be available for students beyond those five years, meaning the change would primarily affect graduate students and those who take longer to complete their undergraduate education. These changes are projected to generate $17.3 billion in savings between 2018 and 2027, nearly a 10 percent reduction from current law, according to the Joint Committee on Taxation (JCT).
The Senate bill makes no changes to these credits.
Deductions, Exemptions, and Exclusions
Currently, the federal government offers a slew of tax deductions related to higher education. The House-passed tax reform bill would impact two of these: the student loan interest deduction, which allows eligible taxpayers to deduct up to $2,500 for interest payments on student loans; and the $4,000 deduction for tuition and related expenses, which is available for filers up to a certain income threshold who do not utilize any of the aforementioned tax credits. The House version would repeal both of these deductions, leaving students unable to deduct tuition expenses or their loan’s interest payments. In contrast, the Senate bill passed through committee would not touch these deductions.
Another proposal involves the taxing of endowment income. Currently, while most private foundations are required to pay a 2 percent excise tax on investment earnings, private non-profit colleges and universities are exempt.2 Both the House and Senate bills would decrease the tax to 1.4 percent, but would also have it apply to endowments of private non-profit universities with at least 500 students and $250,000 in assets per student. According to an analysis by The Chronicle of Higher Education, this change would affect 61 institutions, 30 of which have endowments worth over $1 billion. The JCT estimates that this change would increase revenues for the government by $2.5 billion over 10 years.
Possibly the most contentious of all these proposed changes relates to tuition support that is offered to students by academic institutions. Under current law, their support is excluded from taxable income. This tax preference is especially beneficial for graduate students—many of whom receive free tuition and are therefore only taxed on modest wages offered by institutions. Eliminating this exclusion would be a significant increase in the cost of a graduate education for many students, likely reducing demand for those types of programs. The tax code also currently allows employers to offer up to $5,250 per employee in tax-free educational assistance. The House-passed bill would eliminate both of these provisions, while the Senate bill would maintain them.
These are just several of the noteworthy changes to the tax treatment of higher education in the current tax reform legislation. Simplification of the tax code is well overdue, and these changes may put downward pressure on tuition and student borrowing over the long-term. But as the Senate prepares to debate and vote on this legislation, it is critical that lawmakers pay attention to the potential, maybe unintended, consequences of repealing or reforming these tax provisions and work to ensure that students and their families are not adversely impacted as a consequence of tax reform.