Uncle Sam, Tuition Costs, and the Changing Economy: Tax Incentives for Education Expenses and How to Improve Them

I. INTRODUCTION In the past dozen years, Congress has twice created new means of reducing the income tax burden on taxpayers who pay education expenses at qualifying institutions during the taxable year for which they are filing a return.1 Both were small portions of what became massive pieces of taxation legislation. First, in 1997, came the Hope Scholarship Credit and the Lifetime Learning Credit, eventually codified in the Internal Revenue Code (IRC) as Section 25A.2 Then, in 2001, as part of President George W. Bush's expansive tax cut legislation, Congress added another incentive in the form of a deduction for qualified tuition expenses. This deduction is codified today as Section 222,3 hence the moniker deduction. Members of Congress explained that these additions to me tax code were intended to encourage higher rates of application and enrollment in higher educational institutions by helping taxpayers shoulder the burden of their steep costs.4 In both instances, the incentives were part of broad-based programs put into place by Congress with the support of the president5 that purported to help the middle class find tax relief. This Note will explain these two sections of the tax code and how they work for individual taxpayers. It will also explain the functional difference between the 25A credits and the 222 deduction, and the potential effect of each on an education expense-paying taxpayer's overall liability. Then it will argue that each statute's built-in scheme of keeping itself current (if it has one) is not in sync with Congress's expressed intent. The Note will conclude with proposed correctional measures and a brief assessment of pending legislation that if passed would alter the way these tax incentives work. II. CREDITS, DEDUCTIONS, AND YOU: HOW SECTIONS 25A AND 222 ARE HERE TO HELP A. Why Create a Credit or Deduction? A basic theory that aids in our understanding of taxation and die government's motives in structuring the IRC is that die government can advance its policies by placing higher tax burdens on activities it wishes to discourage and providing tax incentives for tilings it wants to encourage.6 Instead of using such devices as expenditures, interest subsidies, direct federal and federal insurance or guarantee^] of private loans, the government prods taxable entities to behave the way it wants them to through a tax incentive that is generally less costly.7 In return for doing so, their tax liability will drop. By making credits and deductions available to those who incur education expenses in a taxable year, Congress is trying to coax more taxpayers (or their dependents) into returning to or continuing their education at colleges and universities. A unique aspect of education expenses is that a taxpayer might use his or her money to cover them in taxable years that occur before, during, and after the years in which the education is actually obtained.8 With this in mind, Congress has attempted to cover all the bases. For future expenses, Congress offers preferential tax treatment for the use of Coverdell Education Savings Accounts,9 other Qualified Tuition Programs,10 and certain U.S. savings bonds11 to pay for higher education costs. For past expenses, Congress allows a specialized deduction for interest paid on student loans12 and excludes from gross income certain student loan debt forgiveness.13 The Hope and Lifetime Learning Credits and the 222 deduction are benefits related to current expenses.14 A taxpayer is able to use them year-to-year as he or she pays education expenses for which no other exclusion, deduction, or credit is available. B. How do the Hope and Lifetime Learning Credits Work? Like most sections of the IRC, Section 25A is filled with terms of art and nuances regarding eligibility.15 In the simplest terms, the Hope Scholarship Credit will allow a qualifying taxpayer to reduce his or her tax liability for the 2008 tax-year by up to $1,800 per student if at least $2,400 is spent on each student's educational costs,16 which the statute essentially limits to tuition expenses. …