To maximize the impact of higher education investments and achieve desired policy goals, policymakers should have knowledge of the full range of assistance provided to institutions and students, including through spending programs and the tax code.
Middle-Class Squeeze
“The Other Side of the Ledger: Student Aid Through Tax Benefits” explains the history of tax benefits such as tax credits, tax deductions, and qualified tuition programs used to pay for higher education-related expenses.
In an effort to make college more affordable, federal lawmakers have proposed several approaches to make tax benefits—primarily aimed at the middle class—a viable way to supplement the direct student aid programs traditionally targeted at low-income students. Although these efforts began over half a century ago, it was not until the late 1990s that tax benefits for college expenses were written into the tax code. This 14-minute film details important legislative milestones and describes the growth of these benefits.
Savings Plans
Prepaid tuition plans and college savings plans, known collectively as Qualified Tuition Programs or 529 plans, provide tax advantages and incentives to make it easier for families and students to pay for college.
1986
Michigan developed the nation’s first prepaid tuition program, which allowed families to prepay tuition at any Michigan public postsecondary institution at current tuition rates for any child living in Michigan.
1996
The Small Business Job Protection Act established that earnings and disbursements from qualified state tuition programs and college savings plans, later referred to as 529 plans, be exempt from federal taxation starting in the 1996 tax year. Expenses that qualified under the plan included tuition, fees, books, supplies, and equipment required for the attendance of an eligible educational institution.
1997
The Taxpayer Relief Act provided special treatment of 529 accounts by gift and estate tax regulations—both important changes for 529 plan donors and beneficiaries—and defined eligible educational institutions as Title IV institutions. In 2001, Congress made distributions from 529 plans tax-exempt for qualified education-related expenses, including tuition, fees, room and board, books, supplies, and equipment.
“Then we have the so-called 529 plans, where you can deposit money into an account, which each state creates. It goes through without taxes, it accumulates tax-free, it can be withdrawn to pay college expenses—it’s an enormous tax-based savings center for college education.”
Douglas Holtz-Eakin
Chief Economist, President’s Council of Economic Advisors 2001-02
Director, Congressional Budget Office, 2003-05
Director, Congressional Budget Office, 2003-05
Tax Deductions and Credits
A tax deduction reduces a filer’s taxable income at their marginal tax rate. For instance, a filer in the 25 percent tax bracket with a $1,000 deduction saves $250 in taxes. A tax credit reduces the amount a filer pays to the IRS dollar for dollar.
1997
The Taxpayer Relief Act created the Hope Scholarship Tax Credit and Lifetime Learning Tax Credit, which provided a dollar-per-dollar reduction of tax liability for the first two years of postsecondary education up to $1,500. The Lifetime Learning Tax Credit provided a dollar-per-dollar reduction of tax liability for unlimited years of postsecondary education up to $2,000.
2001
The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) enabled taxpayers to claim a Hope Scholarship Tax Credit and Lifetime Learning Tax Credit in the same year that they claim an exclusion from contributions made to an education savings account (e.g., Coverdell and 529 plans.) EGTRRA stipulates that the same expenses can not used for both benefits. It also enabled taxpayers to claim a deduction for qualified tuition and related expenses, which reduced the amount of income subject to tax by up to $4,000 if the tax filer’s adjusted gross income for the taxable year did not exceed a certain amount and expanded eligibility for tax deductions for the interest paid on student loans. It achieves this by increasing the maximum deduction amount to $2,500 and removing the 60-month limit on loan interest deductions.
2006
The Pension Protection Act permanently extended the rule enacted under EGTRRA allowing taxpayers to claim a Hope Scholarship Tax Credit and Lifetime Learning Tax Credit in the same year that they claim an exclusion from contributions made to an education savings account, as long as the same expenses are not used for both benefits.
2009
The American Opportunity Tax Credit (AOTC) was created to temporarily replace the Hope Scholarship Tax Credit for the 2009 and 2010 tax seasons. The AOTC increased the Hope Scholarship Tax Credit limit, expanded the number of years a taxpayer could claim the credit, and made more high- and low-income individuals eligible. It also included course materials as a college expense.
2015
The Protecting Americans from Tax Hikes Act permanently extended AOTC and extended tax deductions for tuition and education expenses through December 2016.
In 1996 there was a debate about balancing the federal budget, between a Democratic president and a Republican Congress. And the Republican Congress was adamant that tax cuts be part of any balanced budget agreement.
Pauline Abernathy
Policy Advisor
White House and U.S. Department of Education, 1995–99
White House and U.S. Department of Education, 1995–99
Want to Learn More?
View additional federal student aid resources below:
Using selected, de-identified data from the population of potential return filers, the National Bureau of Economic Research shows how tax credits are distributed across households with different incomes, along with its causal effects and implications.
This report contrasts higher education tax benefits with traditional student aid, presents a brief history of higher education tax policy over the past 60 years, summarizes key features of the available tax benefits, and provides JCT estimates of revenue losses resulting from individual tax provisions.
Rapidly rising college expenses in the 1990s spurred the 1997 enactment of tax incentives for higher education, which currently include the American opportunity tax credit, the lifetime learning credit, and deductions for tuition and fees and for student loan interest.
