We retired Tax Justice Blog in April 2017. For new content on issues related to tax justice, go to www.justtaxesblog.org
You might be surprised to learn that Congress is likely to extend a tax break that is claimed mostly by high-income individuals paying for graduate education and by families of undergrads who are mistakenly taking this break instead of one that would benefit them more.
The deduction for tuition and related fees is part of the “tax extenders,” which is the nickname often given to a package of provisions that Congress approves every couple of years to extend various arcane tax breaks that mostly go to businesses. This deduction is one relatively small piece of the larger “tax extenders” package, and it’s one that does go to families. But unfortunately, it’s also the most regressive of all the tax breaks for postsecondary education, meaning it’s targeted more to the wealthy than any other education tax break.
Congress last extended the deduction for tuition and related fees in the tax extenders package that was included in the “fiscal cliff” legislation approved on January 1 of 2013. That legislation extended it retroactively to 2012 and prospectively through the end of 2013. The two-year extension cost $1.7 billion.
Here’s a list of reasons why Congress should allow it to remain expired.
The deduction for tuition and related fees mainly supports graduate education.
Americans paying for undergraduate education for themselves or their kids in 2009 or later generally have no reason to use the deduction because starting that year another break for postsecondary education was expanded and became more advantageous. The more advantageous tax break is the American Opportunity Tax Credit (AOTC), which has a maximum value of $2,500. The deduction for tuition and related fees, in contrast, can be taken for a maximum of $4,000, and since it’s a deduction that means the actual tax savings even for someone in the highest income tax bracket (39.6 percent) cannot be more than $1,584.
The AOTC is more generous across the board. Under current law, the AOTC is phased out for married couples with incomes between $160,000 and $180,000, whereas the deduction for tuition and related fees is phased out for couples with incomes between $130,000 and $160,000. For moderate-income families, the AOTC is more beneficial because it is a credit rather than a deduction. The working families who pay payroll and other taxes but earn too little to owe federal income taxes – meaning they cannot use many tax credits – benefit from the AOTC’s partial refundability (up to $1,000).
Given that a taxpayer cannot take both the AOTC and the deduction, why would anyone ever take the deduction? The AOTC is available only for four years, which means it would normally be used for undergraduate education, while the deduction could be used for graduate education or in situations in which undergraduate education takes longer than four years. The deduction can also be used for students who enroll for only a class or two, while the AOTC is also only available to students enrolled at least half-time for an academic period during the year.
For graduate students and others in extended education, under current law the Lifetime Learning Credit (LLC) is generally a better deal than the tuition and fees deduction. Because the upper income limit for the LLC is lower — $124,000 if married, $62,000 if single, the tuition and fees deduction primarily benefits taxpayers whose income is above these thresholds.
Taxpayers confused by all the education tax breaks may mistakenly take the deduction rather than a tax break that benefits them more.
One reason a family paying for undergraduate education would claim the deduction instead of the AOTC is confusion. Because the panoply of education tax breaks is so confusing, many taxpayers mistakenly claim a break that is not the best deal for them. A 2012 report from the Government Accountability Office found that over a fourth of taxpayers eligible for postsecondary education tax breaks don’t take advantage of them, and those who do use them often don’t use the most advantageous tax break for their situation.
The deduction for tuition and related fees is the most regressive tax break for postsecondary education.
The distribution of these tax breaks among income groups is important because if their purpose is to encourage people to obtain education, they will be more effective if they are targeted to lower-income households that could not otherwise afford college rather than well-off families that will send their kids to college no matter what.
The graph below was produced by the Center for Law and Social Policy (CLASP) using data from the Tax Policy Center, and compares the distribution of various tax breaks for postsecondary education as well as Pell Grants.
The graph illustrates that not all tax breaks for postsecondary education are the same, and the deduction for tuition and fees is the most regressive of the bunch. Some of these tax breaks are more targeted to those who really need them, although none are nearly as well-targeted to low-income households as Pell Grants. Tax cuts for higher education taken together are not well-targeted, as illustrated in the bar graph below.
One proposal offered by CLASP would expand the refundability of the American Opportunity Tax Credit (AOTC), represented by the blue bar above, increasing the assistance available to low-income families not helped by the other tax breaks. The proposal offsets these costs — and simplifies higher education tax aid – by eliminating the other tax breaks and reducing AOTC benefits for higher income households