The Student and Family Tax Simplification Act

As my regular readers will recall, I often pass Walden Pond, as I live a few towns away, and while writing at Walden Pond, Thoreau wrote, “Our life is frittered away by detail. Simplify, simplify, simplify! I say, let your affairs be as two or three, and not a hundred or a thousand; instead of a million count half a dozen, and keep your accounts on your thumb-nail.” Partially with this in mind, I like when a bit of proposed tax code aims to provide some level of simplification to our utterly incomprehensible too-long code.

The particular proposal I am looking at today offers to simplify the tax benefits for higher education. as the Ways and Means report states:

• Under current law, there are 15 different tax benefits relating to education that often overlap with one an other.
• The current-law education tax benefits are so complicated that they are ineffective because many taxpayers cannot determine the tax benefits for which they are eligible.
• The IRS publication on tax benefits for education is almost 90 pages long.
• Streamlining education tax benefits would enable taxpayers to understand better the tax benefits for which they qualify.
• The provisions would help to simplify considerably the tax benefits relating to education.

The above puts in perspective just how difficult it is for the average parent to navigate their choices amongst the different benefits. The new proposal appears simple, a 100 percent tax credit for the first $2,000 of certain higher education expenses and a 25 percent tax credit for the next $2,000 of such expenses. So far, so good. A total $2500 gift from Uncle Sam to pay for your child’s college tab. Not so fast, a phase out for MAGI between $86,000 and $126,000 for joint filers and $43,000 and $63,000 for other filers. This is a tough one for me. For a Joint filer, that next $20K of income will kill $2K worth of the tax credit. In effect, a 10% extra phantom tax for the AGI between $86K and $106K for that couple. Many people with college age children are not far from retirement, and on my advice, they might be navigating to avoid the phantom tax that will hit retired couples on their social security income. The effect of this phaseout is that a couple will see a phantom 25% rate for income that should otherwise be taxed at 15%, the 15% bracket I suggest that pre-retirees “top off” by converting some money to their Roth IRA. I suppose that any credit such as this one should have a cap, an income level above which one doesn’t qualify. The real question is whether a joint AGI of $86K is the right level for the phaseout. My own opinion is no, I think $125K or higher is more appropriate. What do you think?

It doesn’t end there. The government gives and the government take away. This provision includes the repeal for the exclusion from United States savings bonds used to pay higher education tuition and fees. In other words, you followed the rules, you patriotically bought US savings bonds with the promise that the growth would not be taxed if these were used to fund higher education. Ouch. The estimate is that this will save $100M over 10 years, so only $10M per year or so. But save in this case means that people will be taxed when they weren’t expecting to pay tax on this money.

Other take-aways include the repeal of any student loan interest deduction, the repeal of deductions for qualified tuition, and the end of the Coverdell Education Savings Account (The account formerly known as the education IRA.)

That’s about it. It seems that simplification comes at a price, and anyone who thinks they understand today’s tax code enough to benefit from it had better keep up on changes that our congress may vote on. To miss these changes can be quite costly.