Exclusion for Employer-Provided Educational Assistance

Educational expenses paid by an employer for its employees generally are deductible by the employer and are not taxable to the employees. The Act expands the exclusion for employer-provided education assistance to graduate-level courses and makes permanent the employee exclusion for both undergraduate and graduate education for courses beginning after 2001.

The exclusion was scheduled to expire after 2001.

Education IRAs

Education IRAs are tax-exempt trusts or custodial accounts established to provide tax-free funds to pay qualified education expenses of designated beneficiaries. Effective after 2001, taxpayers may contribute up to $2,000 (increased from $500) per beneficiary to these trusts. The $2,000 contribution limit is phased out for:

• Married taxpayers filing a joint return with AGI between $190,000 and $220,000
• All other taxpayers with AGI between $95,000 and $110,000
• The Act clarifies that corporations and other entities may make contributions to an education IRA without being subject to any income-limit phase out. Other changes:
• Allow individuals to make contributions until April 15 of the following year
• Expand the class of qualified education expenses to include elementary and secondary school expenses, as well as the costs of college and graduate-level courses
• Expand the class of qualified education expenses to include the purchase of a computer and related equipment, as well as Internet access and related services
• Modify the rule prohibiting contributions after a beneficiary attains age 18 years by providing an exception for students with special needs
• Coordinate education IRAs with HOPE and Lifetime Learning credits

Prepaid Tuition Programs

The definition of a "qualified tuition program" is expanded to include programs maintained by private educational institutions (in addition to state-sponsored tuition programs), but only for the purpose of allowing individuals to purchase tuition credits or certificates for a designated beneficiary -- i.e., not for the purpose of allowing individuals to make contributions to a savings plan maintained by a private entity.

After 2001, distributions made under a qualified tuition program maintained by a state will be excluded from gross income to the extent they are used to pay "qualified higher education expenses." After 2003, the exclusion from gross income will be extended to distributions from qualified tuition programs maintained by a private entity.

The Act allows tax-free rollovers (or transfers of credits) from one program to another for the same designated beneficiary but limited to one per year, and makes other changes to the rollover rules.

Student Loan Interest Deduction

Taxpayers may deduct up to $2,500 annually for student loan interest, subject to certain income limits. This deduction is reduced to the extent taxpayer income exceeds a specified amount, and the deduction is only available during the first 60 months that payment of interest is required.

For years after 2001, the Act increases the income phase-out ranges for eligibility to deduct student loan interest and allows a deduction without regard to the 60-month window.

Deduction for Qualified Higher Education Expenses

An above-the-line deduction is allowed for qualified higher education expenses paid by a taxpayer for tuition and related expenses to an educational institution on behalf of the taxpayer, spouse, or dependent. The amount of the deduction is subject to income limits. No deduction is available for years after 2005.

* In 2004 and 2005, for taxpayers with AGI between $65,001 and $80,000 ($130,001-$160,000 for married filing jointly), the maximum amount of the deduction is $2,000.

Taxpayers cannot simultaneously claim a HOPE or Lifetime Learning credit and deduct higher education expenses in the same tax year with respect to the same student. A deduction, however, may be claimed in the same year as the exclusion for distributions from an education IRA or qualified tuition plan, or the exclusion for interest on education savings bonds. The deduction and exclusion may not be claimed with respect to the same expenses.

Other Education Provisions

• Education awards under two federal health-related scholarship programs generally are eligible for tax-free treatment as qualified scholarships.
• The amount of governmental bonds for public schools that small governmental units may issue without being subject to the arbitrage rebate requirement is increased to $10 million from $5 million.
• The private activities for which tax-exempt bonds may be issued are expanded to include elementary and secondary public school facilities that are privately owned but operated by a public school system under a public-private partnership agreement.