BILL ANALYSIS                                                                                                                                                                                                    

                                                                    AB 1041

                                                                     Page A

          Date of Hearing:  May 11, 2015


                                 Philip Ting, Chair

          AB 1041  
          (Baker) - As Introduced February 26, 2015


          Majority vote.  Tax levy.

          SUBJECT:  Personal income taxes:  education savings accounts

          SUMMARY:  Provides an "above-the-line" deduction for amounts  
          contributed to a Coverdell Education Savings Account (ESA) from  
          gross income, up to $750 per taxable year.  Specifically, this  

          1)Provides a deduction for an amount contributed by a taxpayer  
            during the taxable year to an ESA, not to exceed $750 per  
            taxable year, except as otherwise provided.


                                                                    AB 1041

                                                                     Page B

          2)Defines a "coverdell education savings account" by reference  
            to the Internal Revenue Code (IRC) Section 530, as modified by  
            Revenue and Taxation Code (R&TC) Section 23712.

          3)Provides that for purposes of applying IRC Section 530, the  
            basis for the ESA shall be reduced by an amount equal to this  

          4)Provides that for taxable years beginning on or after January  
            1, 2014, IRC Section 62(a) is modified to provide that this  
            deduction shall be allowed in computing adjusted gross income.
          5)Takes effect immediately as a tax levy.

          EXISTING LAW:  

          1)Conforms to IRC Section 530 as of the "specified date" of  
            January 1, 2009, with modifications, and thus generally  
            conforms to the federal rules that apply to qualified  
            education expenses.  California modifies the additional  
            10-percent tax on excess distributions to instead be an  
            additional tax of 2.5 percent for state purposes.  California  
            law does not allow a deduction for qualified higher education  
            expenses.  IRC Section 530 provides for the use of ESAs, which  
            are used exclusively for the purpose of paying qualified  
            education expenses of a named beneficiary.  ESAs are an  
            investment trust account specifically designated for qualified  
            education costs, which include both K-12 expenses and higher  
            education expenses.  For 2013, the maximum annual  
            contributions to an ESA may not exceed $2,000 per designated  
            beneficiary and may not be made after the designated  
            beneficiary reaches age 18, except in cases of a special needs  
            beneficiary.  Provides a phase out of contributions for  
            taxpayers with modified AGI between 95,000 and 110,000  
            ($190,000 and $220,000 for married taxpayers filing a joint  


                                                                    AB 1041

                                                                     Page C

          2)Defines "qualified educational expenses," under IRC Section  
            530, to include "qualified higher education expenses" and  
            "qualified elementary and secondary education expenses."  The  
            term "qualified higher education expenses" includes tuition,  
            fees, books, supplies, and equipment required for the  
            enrollment or attendance of the designated beneficiary at an  
            eligible education institution, regardless of whether the  
            beneficiary is enrolled at an eligible educational institution  
            on a full-time, half-time, or less than half-time basis.  The  
            funds for "qualified elementary and secondary education  
            expenses" can be used to cover the costs of attending  
            elementary and secondary school.  In addition to tuition,  
            these costs can include uniforms, tutoring, computers,  
            software, and transportation.

          3)Provides that contributions to an ESA are not tax-deductible,  
            but the earning grow-tax free, and so do withdrawals, as long  
            as the distributions are used for qualified education  
            expenses.  However, ESAs are subject to the unrelated business  
            income tax imposed by IRC section 511.  Distributions from an  
            ESA are excludable from the gross income of the distributee  
            (i.e., the student) to the extent that the distribution does  
            not exceed the qualified education expenses incurred by the  
            beneficiary during the year the distribution is made.  The  
            earnings portion of an ESA distribution not used to pay  
            qualified education expenses is includible in the gross income  
            of the distributee and generally is subject to an additional  
            10-percent tax.<1>

          4)Conforms to IRC Section 529 as of the "specified date" of  
            January 1, 2009, with certain modifications, including a  
            modification to the 10% tax on excess distributions to instead  
            be an additional tax of 2.5% for state purposes.
          <1>This 10-percent additional tax does not apply if a  
          distribution from an education savings account is made on  
          account of the death or disability of the designated  
          beneficiary, or if made on account of a scholarship received by  
          the designated beneficiary.  


                                                                    AB 1041

                                                                     Page D

          5)Provides its own IRC Section 529 qualified tuition program,  
            known as the Golden State Scholarshare Trust (ScholarShare).   
            ScholarShare enables taxpayers to save for college by putting  
            money in tax-advantaged investments.  After-tax contributions  
            allow earnings to grow tax-deferred, and disbursements, when  
            used for tuition and other qualified expenses, are federal and  
            state tax-free.  Distributions in excess of qualified higher  
            education expenses incurred for the beneficiary is generally  
            subject to income tax and an additional 2.5% tax for state  
            purposes.  Limits the total amount of contributions to a  
            beneficiary in a 529 qualified tuition program to $371,000.   
            Accounts that have reached the limit may continue to accrue  
          FISCAL EFFECT:  The Franchise Tax Board (FTB) estimates General  
          Fund revenue loss of $350,000 in fiscal year (FY) 2015-16,  
          $450,000 in FY 2016-17, and $450,000 in FY 2017-18.


          1)Author's Statement:  The author has provided the following  
            statement in support of this bill:

               This bill proposes a new state tax deduction of up to $750  
               for contributions made to Coverdell education savings  
               accounts that will encourage parents to invest in their  
               children's kindergarten through college education.  The  
               deduction would be "above the line," which means it will be  
               available to all taxpayers regardless of whether they  
               itemize deductions on their tax returns.  By providing an  
               additional incentive for more people to save money for  
               their child's kindergarten through college education,  
               children will benefit in the long term with a more solid  
               foundation upon which to further their education.


                                                                    AB 1041

                                                                     Page E

           2)Arguments in Support  :  The California Catholic Conference  
            states that, "[f]inancial pressures weighing upon California  
            families have made it difficult to ensure a quality elementary  
            and secondary education and to generate funds for college.   
            While families can set aside funds in support of their  
            children's learning needs as they arise through a Coverdell  
            ESA, additional state tax relief is needed to encourage such  
            educational planning." 

           3)Favoring Higher Income Earners  .  According to a report by the  
            Government Accountability Office (GAO), less than 3% of  
            families have 529 or ESA plans and those who do tend to be  
            wealthier.  (Higher Education: A Small Percentage of Families  
            Save in 529 Plans, GAO, Dec. 2012.)  Specifically, families  
            with 529 and ESA plans had a median income of $142,000 per  
            year and a median financial asset value of about $413,500.  It  
            was also said that families with 529 and ESA plans tend to  
            have higher levels of education, which may increase the  
            likelihood that their children will attend college.
            The report outlined several reasons why low-income families  
            participate far less in 529 and ESA plans, such as a lack of  
            awareness, confusion as to how the plan works, and differences  
            among the various plans.  However, 68% of those surveyed  
            stated a lack of money as the major reason for not  
            participating.  In the end, it is difficult to encourage  
            families to save for college when they have little or no  
            disposable income.

           4)High Cost of a Formal Education  .  State support for higher  
            education has been dramatically reduced because of budget  
            crises over the last 10 years.  According to a study by the  
            Public Policy Institute of California, in 2010-11 California  
            spent $1.6 billion less in higher education than it did 10  
            years earlier, adjusted for inflation.  (Hans Johnson,  
            Defunding Higher Education:  What are the Effects on College  
            Enrollment, Public Policy Institute of California, May 2012.)   
            The provisions of this bill are meant to counteract the  


                                                                    AB 1041

                                                                     Page F

            skyrocketing costs of an education by providing a deduction  
            for contributions made to ESA.  Instead of forgoing General  
            Fund revenues that predominantly favor higher income earners,  
            these funds may be better utilized if directly appropriated to  
            the state's University of California, California State  
            University, and Community College system.

           5)Proposition 30  .  In general, Proposition 30 increased the  
            marginal tax rate for those making above $250,000 and  
            increased the statewide sales tax rate from 7.25% to 7.5%.   
            Proposition 30 was estimated to increase General Fund revenue  
            by about $6 billion per year, which would primarily be used to  
            restore funding to California's public school system.  The  
            provisions of this bill are meant to counteract the lack of  
            funding once available to K-12 education.  Specifically, this  
            bill seeks to remedy the fact that many schools are unable to  
            provide school supplies and books.  However, as noted in the  
            Governor's Budget Summary, the budget for FY 2014-15 provides  
            $61.6 billion in Proposition 98 funding, an increase of $6.3  
            billion over the 2013 budget act level.  It appears that new  
            revenues, provided in part because of the passage of  
            Proposition 30, have translated into additional funding for  
            California's K through 12 school system.

           6)Is This Bill Needed  ?  The California Supreme Court ruled in  
            Hartzell v. Connell (1984) 35 Cal.3d 899, 201) that pupil fees  
            violate the constitutional right to a free education.   
            Specifically, the court ruled that extracurricular activities  
            also must be free because they are an integral component of  
            public education and a part of the educational program.  In  
            September 2010, the American Civil Liberties Union (ACLU)  
            filed a class action lawsuit alleging the unconstitutional  
            assessment of pupil fees by school districts [Jane Doe, et al.  
            v. State of California, et al., (Super. Ct. Los Angeles  
            County, 2010, BC445151)].  The lawsuit was brought forward  
            because ACLU reports showed that more than 50 public school  
            districts required pupils to pay fees for textbooks,  
            workbooks, science labs, physical education uniforms,  
            classroom materials, and extracurricular activities.  Instead  


                                                                    AB 1041

                                                                     Page G

            of moving forward with the lawsuit, the ACLU and interested  
            parties sought a legislative solution.  As a result, AB 1575  
            (Lara), Chapter 776, Statutes of 2012, which was sponsored by  
            ACLU, codified the long held constitutional prohibition on the  
            imposition of pupil fees and established procedures to ensure  
            compliance with the prohibition.

            Since the passage of AB 1575, many schools have stopped  
            imposing fees for participation and, in some cases, are paying  
            for items that were traditionally paid for by pupils and  
            parents.  Most recently, school districts have informed  
            parents that caps and gowns will be provided free of charge.   
            Within the last year, parents throughout California have been  
            utilizing compliance procedures to challenge school districts  
            that require families to pay for Advanced Placement exams,  
            classrooms supplies, workbooks, and school uniforms.  (Loretta  
            Kalb, California to Schools:  Student don't have to pay for  
            graduation attire, other items 'integral' to education,  
            Sacramento Bee, May 7, 2014.)  In some cases, parents and  
            activists are even challenging "supply lists" posted by school  
            for returning student.  One parent, in the San Juan School  
            District, received a letter outlining a list of supplies that  
            children would need at the beginning of the year.  The list  
            included items such as tissue paper, binders, pencils and  
            pens.  The supplies cost parents between $70 and $100.  In  
            response to the challenge to required supplies, the school  
            notified parents that all necessary materials will be provided  
            to school children and that "supply lists" are suggestions,  
            not required for full participation.  Schools across  
            California have begun making similar changes to "required"  
            items and fees that are imposed on pupils.  In most cases,  
            schools have stated that items will be provided free of  

           1)Private School Subsidy  :  Unlike a 529 College Savings plan,  
            ESA plans allow taxpayers to withdraw and make payments for  
            K-12 educational expenses.  K-12 educational expenses,  
            however, are not limited to public schools.  Funds can also be  


                                                                    AB 1041

                                                                     Page H

            used to pay for private school tuition.  The Committee may  
            wish consider whether subsidizing private education and  
            educational courses is an appropriate use of public funds.


          California Catholic Conference


          None on file

          Analysis Prepared by:Carlos Anguiano / REV. & TAX. / (916)