The government's stimulus plan made some changes to higher education funding.
College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to firstname.lastname@example.org.
The American Recovery and Reinvestment Act of 2009 includes two temporary changes that affect the funding of higher education. First, the Act expands the definition of qualified higher education expenses under Code section 529. Second, the Act enhances the Hope Scholarship Credit. In general, these changes are effective only for 2009 and 2010.
Bailout for Computer Manufacturers
Expansion of Qualified Higher Education Expenses. The Act temporarily expands the definition of QHEEs to include computer technology and equipment, and Internet access and 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 educational institution. This expansion applies only to expenses paid or incurred during 2009 or 2010.
This change addresses, for two years, the specific issue of whether a computer for a student qualifies as a QHEE. However, the amendment is unclear in many respects. Further, the amendment may be of limited use to many account owners who have recently seen significant declines in the value of their 529 accounts and are more concerned about whether the accounts are sufficient to pay tuition, and less concerned about new ways to spend the money in the 529 accounts. However, for those few who may have excess funds in 529 accounts, the Amendment provides a new spending opportunity.
Old Provision. Section 529(e)(3) defines the QHEEs that may be paid from a section 529 account without federal income tax on the distribution. Section 529(e)(3) previously provided:
(A) IN GENERAL. - The term "qualified higher education expenses" means -
(i) tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution; and
(ii) expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with such enrollment or attendance.
This definition of QHEEs did not cover the cost of a computer to be used by the student unless the computer was required for attendance at the school, even though a computer is a necessary and reasonable expense for any college student.
The tax court in Gorski v. Commissioner, T.C. Summary Opinion 2005-112 (August 4, 2005) adopted the position that the purchase of a computer for a college student was not a QHEE under section 529(e)(3)(A) of the Code where it was not required for attendance at the school. The case did not involve a 529 savings account but rather involved the issue of whether the 10% additional tax should be imposed on an IRA withdrawal to the extent it was used to purchase the computer. Early IRA withdrawals are not subject to the 10% additional tax if they are used for QHEEs as defined in section 529 of the Code. The tax court reasoned that the Code section provides that supplies or equipment be "required" by the school for attendance. The court concluded that because the university being attended by the child did not require that a student own a computer, it was not a QHEE. The court was not moved by the petitioner's argument that the university only had a limited number of computers available for student use and that his daughter would have to walk back and forth from the library to her dorm room late at night in order to use the school's computers. Nor was the tax court moved by the argument that the professors used an Internet based system to post syllabi and course assignments and that certain university information was available only over the Internet.
New Provision. The Act amends section 529(e)(3)(A) to add a new clause (iii):
(iii) expenses paid or incurred in 2009 or 2010 for the purchase of any computer technology or equipment (as defined in section 170(e)(6)(F)(i)) or Internet access and 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 educational institution.
Clause (iii) shall not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature.
This amendment to Code section 529(e)(3)(A) only applies to expenses paid or incurred after Dec. 31, 2008. Therefore, an account owner may not take reimbursement out of a 529 account for a computer purchased and paid for before Jan. 1, 2009.
Expenses Included. So exactly what expenses are included? Code section 170(e)(6)(F)(i) says that the "term 'computer technology or equipment' means computer software (as defined by section 197(e)(3)(B)), computer or peripheral equipment (as defined by section 168(i)(2)(B)) and fiberoptic cable related to computer use."
Continuing on our treasure hunt through the Code, section 168(i)(2)(B)(i) defines "computer or peripheral equipment" to include any computer and "any related peripheral equipment." (I think I could have figured that much out without the Code section.) Code section 168(i)(2)(B) continues as follows:
(ii) COMPUTER. - The term "computer" means a programmable electronically activated device which -
(I) is capable of accepting information, applying prescribed processes to the information, and supplying the results of these processes with or without human intervention, and
(II) consists of a central processing unit containing extensive storage, logic, arithmetic, and control capabilities.
(iii) RELATED PERIPHERAL EQUIPMENT. - The term "related peripheral equipment" means any auxiliary machine (whether on-line or off-line) which is designed to be placed under the control of the central processing unit of a computer.
(iv) EXCEPTIONS. - The term "computer or peripheral equipment" shall not include -
(I) any equipment which is an integral part of other property which is not a computer,
(II) typewriters, calculators, adding and accounting machines, copiers, duplicating equipment, and similar equipment, and
(III) equipment of a kind used primarily for amusement or entertainment of the user.
With respect to hardware, a laptop or a desktop, modem and printer should qualify provided that they are not used primarily for "amusement or entertainment." I will even venture that a Blackberry, PDA (personal data assistant), iTouch; iPhone or similar handheld devices should qualify if not used primarily for amusement or entertainment. Do computer speakers qualify if not primarily used for recreation, but primarily used to listen to webcast lectures or to run programs to help the student in a language course? Perhaps. Clearly, a line needs to be drawn at equipment such as special game pads and audio equipment designed to enhance a beneficiary's video game experience.
Now as to the software. Section 197(e)(3)(B) of the Code defines "computer software" as "any program designed to cause a computer to perform a desired function. Such terms shall not include any database or similar item unless the database or item is in the public domain and is incidental to the operation of otherwise qualifying computer software." So it sounds like most computer software programs that I might purchase, including a calendaring program, Excel, estate tax calculation programs, Quicken, tax preparation software, would be included. Specifically not included would be software designed for sports, games or hobbies.
In addition to the hardware and software, section 529(e)(3)(A)(iii) also permits the payment of Internet access and related services from the section 529 account.
Who Can Benefit. With respect to hardware, software and Internet access, new Code section 529(e)(3)(A)(iii) appears to be quite liberal in permitting them to be used by the "beneficiary and the beneficiary's family." Thus it would appear that the 529 account could be used to pay for not only the beneficiary's laptop for use at school, Internet access at school (if not already provided by the University) but also for the family's home computer and related equipment, non-sport or -game software and Internet access.
Who qualifies as the beneficiary's family? "Family" is not defined in Code section 529, and the amendment does not use the term "member of the family," which is defined in the Code. Is it sufficient if the computer technology or equipment is used by any member of the beneficiary's family, even if it is not used by the beneficiary? Can Mom's personal PDA or Blackberry qualify?
The best answer in terms of construction and the purpose of Code section 529 may arise from focusing on the conjunction "and" in the phrase "to be used by the beneficiary and the beneficiary's family." Under this construction the beneficiary must use the technology or equipment at least some of the time while enrolled at an eligible educational institution. The phrase "and the beneficiary's family" just indicates that the fact that the technology or equipment might also be used by other family members will not disqualify the expense. This construction is consistent with the Conference Report to the Act, which refers to "computer technology and equipment to be used by the designated beneficiary." Thus Mom's personal Blackberry or a laptop solely used by a sibling of the beneficiary would not qualify, but any computer that may be used by the beneficiary while at home would qualify. This construction also allows a common sense construction of "family" as relatives living in the same household.
If a computer is purchased with funds from a 529 account, the account owner would have an interest in ensuring that it is not primarily used for amusement or entertainment. What a wonderful excuse to limit a child's video game time!
Timing of Purchase. Literally, new Code section 529(e)(3)(A)(iii) does not require that the hardware or software be purchased while the 529 designated beneficiary is enrolled at an eligible educational institution but only requires that it be used while the beneficiary is enrolled at an eligible educational institution. At least one commentator has suggested that this new provision of section 529 might be used to purchase a computer now, while the beneficiary is not enrolled at an eligible educational institution, in anticipation that the computer will be used by the beneficiary once he or she does enroll at an eligible educational institution. This would seem to be a result not intended by Congress.
I think it unlikely that the IRS would treat a distribution from a 529 account as a qualified distribution if it is used to purchase a computer or software when the beneficiary is not yet enrolled at an eligible educational institution (or at least is not so enrolled by the end of the calendar year) because there would be no way to determine in the year the distribution is made whether or not the hardware or software in fact will meet the requirements of section 529(e)(3)(A)(iii). The beneficiary might, contrary to expectations, never enroll at an eligible educational institution. Alternatively, the hardware or software might never be used while the beneficiary is enrolled at an eligible educational institution if the hardware or software is damaged, destroyed or becomes obsolete prior to the beneficiary's enrollment.
Conclusion. This new provision of section 529 provides an opportunity when a 529 account established for a beneficiary may not be exhausted by payments of tuition, room and board where applicable, books and supplies and when there is not a suitable successor beneficiary for the account. In other words, if a 529 account for a beneficiary is "overfunded," the family might consider using some of the funds to update their home computer system or the beneficiary's computer while the beneficiary is still enrolled in college or graduate school.
American Opportunity Tax Credit
The American Recovery and Reinvestment Act of 2009 also temporarily revises the Hope Scholarship Credit for 2009 and 2010. Prior to the Act, a parent could claim a tax credit for 100% of the first $1,200 and 50% of the next $1,200 of a dependent child's college tuition and mandatory fees, for a maximum $1,800 annual tax credit per child. The credit was available only for the first two years of post-secondary education. After the first two years of post-secondary education, a taxpayer could claim a Lifetime Learning Credit for 20% of up to $10,000 in combined tuition and mandatory fees for himself or herself, the taxpayer's spouse and the taxpayer's dependent children.
Increased Credit. The American Opportunity Tax Credit enhances the Hope Scholarship Credit and makes it available for the first four years of post-secondary education but only for years 2009 and 2010. The American Opportunity Tax Credit permits a credit of 100% of qualified tuition and related expenses paid by the taxpayer up to $2,000 plus 25% of expenses in excess of $2,000 and up to $4,000. Thus the maximum credit is now $2,500.
Expanded Permitted Expenses. The Act also expands the definition of "qualified tuition and related expenses" to include course materials as well as tuition and fees. Previously, the costs of books, supplies and equipment were considered to be a qualified tuition and related expense only if they were required to be paid directly to the college or university as a condition of enrollment or attendance.
Higher AGI Limits. In addition, the adjusted gross income limits to qualify for the Hope Scholarship Credit have been increased, thus making the credit available to more taxpayers. Before the Act, the deduction was phased out for singles with adjusted gross income between $50,000 and $60,000 and for married couples filing jointly with adjusted gross income between $100,000 and $120,000. Under the Act, the phaseout does not begin until adjusted gross income of $80,000 is reached ($160,000 in the case of a married couple filing jointly). The Act provides:
(4) INCREASE IN AGI LIMITS FOR HOPE SCHOLARSHIP CREDIT. - In lieu of applying subsection (d) with respect to the Hope Scholarship Credit, such credit (determined without regard to this paragraph) shall be reduced (but not below zero) by the amount which bears the same ratio to such credit (as so determined) as -
(A) the excess of -
(i) the taxpayer's modified adjusted gross income (as defined in subsection (d)(3)) for such taxable year, over
(ii) $80,000 ($160,000 in the case of a joint return), bears to
(B) $10,000 ($20,000 in the case of a joint return).
(5) CREDIT ALLOWED AGAINST ALTERNATIVE MINIMUM TAX. - In the case of a taxable year to which section 26(a)(2) does not apply, so much of the credit allowed under subsection (a) as is attributable to the Hope Scholarship Credit shall not exceed the excess of -
(A) the sum of the regular tax liability (as defined in section 26(b)) plus the tax imposed by section 55, over
(B) the sum of the credits allowable under this subpart (other than this subsection and sections 23, 25D, and 30D) and section 27 for the taxable year.
Any reference in this section or section 24, 25, 26, 25B, 904 or 1400C to a credit allowable under this subsection shall be treated as a reference to so much of the credit allowable under subsection (a) as is attributable to the Hope Scholarship Credit.
Portion of Credit Refundable. Forty percent of the Hope Scholarship Credit is now potentially refundable to a taxpayer who cannot use it to offset tax liability. The Act provides:
(6) PORTION OF CREDIT MADE REFUNDABLE. - 40 percent of so much of the credit allowed under subsection (a) as it attributable to the Hope Scholarship Credit (determined after application of paragraph (4) and without regard to this paragraph and section 26(a)(2) or paragraph (5), as the case may be) shall be treated as a credit allowable under subpart C (and not allowed under subsection (a)). The preceding sentence shall not apply to any taxpayer for any taxable year if such taxpayer is a child to whom subsection (g) of section 1 applies for such taxable year.
Thus up to $1,000 may be refunded to a taxpayer who has zero tax liability. However, no portion of the credit is refundable if the taxpayer is a child who has unearned income subject to the "Kiddie Tax."
To comply with certain Treasury regulations, we state that (i) this article is written to support the promotion and marketing of the transactions or matters addressed herein, (ii) this article is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (iii) each taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.