|Stimulus Act Eases Paying for College in 2009/2010
Taxpayers paying for college in 2009 and 2010 can count more expenses toward popular tax incentives and may get a bigger refund from education credits.
June 11, 2009
For parents paying college-related expenses during 2009 and 2010, the American Recovery and Reinvestment Act of 2009 (the Stimulus Act) increased the Hope Scholarship Credit and made it partially refundable and also expanded the definitions of qualified expenses for several popular education tax incentives. This article first summarizes the relevant code sections that define qualified college expenses then explains the changes provided by the Stimulus Act.
Qualified Education Expenses
Higher education expenses can be lumped into three broad categories: tuition and fees paid directly to the college or university and required for enrollment; room and board and other personal expenses incurred while away from home at college; and books, supplies and equipment used for educational purposes. Each particular tax incentive defines qualified expenses, but most refer back to one of two code sections, §529(e) and §25A(f), discussed in more detail below:
§529(e)(3) applies to §529 plans, higher education related withdrawals from Roth and Traditional IRAs and Coverdell Education Savings Accounts. For years — other than 2009 and 2010 (discussed below) — §529(e)(3)(A) defined qualified higher education expenses (QHEE) as "tuition, fees, books, supplies and equipment required for the enrollment or attendance &helip; at an eligible institution" (emphasis added). §529(e)(3)(B) adds room and board to the list of qualifying expenses for students attending at least half time. Note that the expenses must be required for enrollment. The Tax Court emphasized the required nature of the expenses when it concluded the purchase of a computer was not a QHEE for purposes of avoiding penalties on IRA withdrawals since, although useful, the computer was not required as a condition of enrollment (see Gorski v. Commissioner, T.C. Summary Opinion 2005-112).
For Coverdell ESAs (Education Savings Accounts), qualified expenses include those listed in §529(e)(3) and also very broad categories of expenses for K-12 education including uniforms and after-school care. See §530(b)(3).
§25A(f) defines qualified expenses for purposes of the Hope and Lifetime Learning Credits and the deduction allowed under §222. For these tax incentives, qualifying expenses are limited to "tuition and fees required for the enrollment or attendance" at an eligible institution for courses of instruction. "Fees" is a broad term and includes many expenses required to be paid to the institution. For example, mandatory equipment rental fees as part of a science class would qualify. Unless books must be purchased from the institution as a condition of enrollment, those expenses would not qualify. The rules specifically exclude "student activity fees, athletic fees, insurance expenses or other expenses unrelated to an individual's academic course of instruction." (§25A(f)(1)(C)). Room and board is not included.
Grandparents or other family members funding educational expenses for non-dependents can exclude from gift tax unlimited payments towards tuition each year only if the tuition is paid directly to the educational organization. See §2503(e).
The chart below indicates the applicable Code section and the categories of expenses that qualify for each program.
Changes by the American Recovery and Reinvestment Act of 2009
The Stimulus Act both broadened the definition of qualified educational expenses for purposes of both §529 and §25A and expanded the maximum credit available under the Hope Scholarship Credit.
Expanded Qualifying Educational Expenses
The Stimulus Act amended Section 529 to add new §529(e)(3)(A)(iii), which broadens qualified higher education expenses to include "expenses paid or incurred in 2009 or 2010 for the purchase of any computer technology or equipment &helip; or Internet access or related services, if such technology, equipment or services are to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is enrolled at an eligible education institution." So instead of the equipment purchase being required for attendance, the old burden of proof, the new standard simply requires that the equipment be used by the students and their family while they are enrolled at a qualifying school.
The types of purchases that qualify are broad and include computers and most equipment attached to or run by the computer. Stand-alone copiers, for example, do not appear to qualify, but a four-in-one copier/printer/fax/scanner would. A PDA (personal digital assistant) like a BlackBerry or iPhone would likely qualify if used for educational purposes (e.g., podcasts). Equipment and software primarily used for amusement or entertainment of the user do not qualify.
Changes to the Hope Scholarship Credit
The Stimulus Act also added new §25A(i) to the Code, which temporarily changes the name of the Hope Scholarship Credit to the American Opportunity Tax Credit (AOTC) for 2009 and 2010 and makes two taxpayer-friendly changes. The maximum credit allowed was increased from $1,800 to $2,500, equal to 100 percent of the first $2,000 of qualifying expenses plus 25 percent of the next $2,000. The AOTC is partially refundable for the first time up to 40 percent of the AOTC.
§25A(i) also amended §25A(f) to add "course materials" to the list of qualified expenses that previously included only tuition and fees. Neither the Code nor the legislative history defines "course materials." However, on the IRS Web site announcing the Stimulus Act changes, course materials are defined as "books, supplies and equipment needed for a course of study whether or not the materials are purchased from the educational institution as a condition of enrollment or attendance."
§25A(i)(3) states that §25A(f)(1)(A) "shall be applied" with the expanded definition, but does not limit the change to the AOTC. However, the legislative history indicates Congress intended only to expand the definition of qualified expenses for purposes of the AOTC. It is unclear how to resolve the conflict between the committee report and the Code. Until a technical correction/clarification is made, tax practitioners should be cautious applying the expanded definition to the Lifetime Learning Credit or the §222 deduction, both of which also refer to the §25A(f)(1) definition.
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LeAnn Luna is an Associate Professor of Accounting and holds a dual appointment with the Department of Accounting and Information Management and the Center for Business and Economic Research, both at The University of Tennessee.