BILL ANALYSIS Ó
SENATE COMMITTEE ON GOVERNANCE AND FINANCE
Senator Robert M. Hertzberg, Chair
2015 - 2016 Regular
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|Bill No: |SB 1437 |Hearing |5/11/16 |
| | |Date: | |
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|Author: |Moorlach |Tax Levy: |Yes |
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|Version: |2/19/16 |Fiscal: |Yes |
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|Consultant|Bouaziz |
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Personal income taxes: deductions: education expenses:
education savings accounts
Allows an "above-the-line" deduction for contributions to
Coverdell Education Savings Accounts and a deduction for
qualified education related expenses.
Background
Coverdell Education Savings Account. Established by federal law,
a Coverdell Education Savings Account (ESA) is a trust or
custodial account created exclusively for the purpose of paying
qualified education expenses of a named beneficiary. Annual
contributions to a Coverdell account may not exceed $2,000 per
designated beneficiary and generally may not be made after the
designated beneficiary reaches age 18. The contribution limit
is phased out for taxpayers with a modified AGI between $95,000
and $110,000 ($190,000 and $220,000 for married taxpayers filing
a joint return); the AGI of the contributor, and not that of the
designated beneficiary, controls whether a contribution is
permitted by the taxpayer.
Distributions from an ESA are excluded from the gross income of
the student to the extent that the distribution does not exceed
the qualified education expenses incurred by the beneficiary the
year the distribution is made. The earnings portion of an ESA
distribution not used to pay qualified education expenses is
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includible in the gross income of the student and generally
subject to an additional 10% tax. Tax-free transfers or
rollovers of account balances from one ESA to another ESA are
permitted, provided that the new beneficiary is a member of the
family of the prior beneficiary and is under age 30 (except in
the case of a special needs beneficiary).
In general, any balance remaining in an ESA is deemed to be
distributed within 30 days after the date that the beneficiary
reaches age 30 (or, if the beneficiary dies before attaining age
30, within 30 days of the date that the beneficiary dies).
Qualified education expenses include "qualified higher education
expenses" and "qualified elementary and secondary education
expenses," and are defined as follows:
"Qualified higher education expenses" means expenses for
undergraduate or graduate-level courses, and includes
expenses for tuition, fees, books, supplies, and equipment
required for the enrollment or attendance of the designated
beneficiary at an eligible educational 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, certain room and board
expenses for any period during which the beneficiary is at
least a half-time student, and amounts paid or incurred to
purchase tuition credits, or to make contributions to an
account, under a qualified tuition program for the benefit
of the beneficiary of an ESA.
"Qualified elementary and secondary education expenses"
means expenses for enrollment or attendance of the
beneficiary at a public, private, or religious school
providing elementary or secondary education (kindergarten
through grade 12), and include tuition, fees, academic
tutoring, special needs services, books, supplies, room and
board, uniforms, transportation, and supplementary items or
services (including extended day programs) required or
provided by such a school in connection with such
enrollment or attendance of the designated beneficiary, and
the purchase of any computer technology or equipment 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
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beneficiary is in elementary or secondary school. Computer
software primarily involving sports, games, or hobbies is
not considered a qualified elementary and secondary
education expense unless the software is predominantly
educational in nature.
California law generally conforms to federal law for ESAs,
modified to provide that the federal additional 10% tax on
excess distributions is instead an additional tax of 2.5% for
state purposes.
Deduction for certain education-related expenses. California
law allows various income tax credits, deductions, and sales and
use tax exemptions to provide incentives to compensate taxpayers
that incur certain expenses, such as child adoption, or to
influence behavior, including business practices and decisions,
such as research and development credits. The Legislature
typically enacts such tax incentives to encourage taxpayers to
do something that but for the tax credit, they would not do.
The Department of Finance is required to annually publish a list
of tax expenditures. Currently, tax expenditures exceed $57
billion dollars. Federal law lacks an education deduction for
K-12 education expenses.
Proposed Law
Senate Bill 1437 provides an above-the-line deduction for
contributions to an ESA, not to exceed $750 per taxable year.
SB 1437 also provides an above-the-line deduction for qualified
education related expenses incurred for the benefit of a
dependent child paid by a qualified taxpayer. The bill defines
the following terms:
"Dependent child" means one or more children who are
dependents for federal tax purposes, attend grades K-12
full-time, and are under the age of 21.
"Qualified amount" would mean the amount paid or
incurred for qualified education related expenses.
"Qualified education-related expenses" would mean the
kindergarten or any of grades 1 to 12, inclusive, costs of
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any of the following:
o The rental or purchase of educational
equipment required for classes during the regular
school day; computers, computer hardware, and
educational computer software used to learn academic
subjects.
o Fees for college courses at public
institutions or independent nonprofit colleges, or for
summer school courses that satisfy high school
graduation requirements.
o Psychoeducational diagnostic evaluations to
assess the cognitive and academic abilities of
dependent children; special education and related
services for dependent children who have an
individualized education program or its equivalent.
o Out-of-school enrichment programs, tutoring,
and summer programs that are academic in nature.
o Public transportation or third-party
transportation expenses for traveling directly to and
from school.
o Excludes any expenses for items as provided in
this provision that also are used in a trade or
business.
"Qualified taxpayer" would mean a parent or legal
guardian of one or more dependent children who meets all of
the following requirements:
o Both the dependent children and the parent or
guardians reside in California when the qualified
education-related expenses are paid or incurred.
o Household adjusted gross income does not
exceed 250% of the federal Income Eligibility
Guidelines published by the Food and Nutrition Service
of the United States Department of Agriculture for use
in determining eligibility for reduced price meals.
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The deduction is limited to $2,500 per year. SB 1437 applies to
taxable years beginning on or after January 1, 2016 and before
January 1, 2021.
State Revenue Impact
According to the Franchise Tax Board (FTB), SB 1437 results in
revenue losses of $20.4 million in fiscal year (FY) 2016-17,
$20.45 million in FY 2017-18, and $21.45 million in FY 2018-19.
Comments
1. Purpose of the bill. According to the author, "SB 1437 would
combine a state tax incentive, along with a new measure of tax
relief, to support families in personally saving and caring for
their children's learning needs from kindergarten through
college. As a tax incentive this bill will encourage, through a
$750 state tax deduction, contributions made to a federal
Coverdell Education Savings Account (ESA) to save for qualified
educational expenses at public and private schools, colleges,
and universities. As tax relief this bill would allow working
and middle-class families, with incomes at or below 250 percent
of federal reduced lunch guidelines, a $2,500 deduction, for
K-12 education-related expenses incurred on behalf of their
dependent children attending California schools. SB 1437 will
encourage families to put away more money for college to ease
future student debt burdens, while also saving for college
preparedness should K-12 educational needs arise. SB 1437 will
additionally aid families in providing resources and services
that are paramount to K-12 learning to help close learning gaps,
promote prevention and recovery, and lessen the number of high
school graduates who enter college needing remedial assistance."
2. Tax expenditures. Existing law provides various credits,
deductions, exclusions, and exemptions for particular taxpayer
groups. In the late 1960s, U.S. Treasury officials began
arguing that these features of the tax law should be referred to
as "expenditures," since they are generally enacted to
accomplish some governmental purpose and there is a determinable
cost associated with each (in the form of foregone revenues).
This bill would increase an existing tax expenditure. The
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tradeoff for increasing the tax expenditure, resulting in
revenue losses, is higher taxes or reductions to other services
or programs.
3. How is tax expenditure different from a direct expenditure?
As the Department of Finance notes in its annual Tax Expenditure
Report, there are several key differences between tax
expenditures and direct expenditures. First, tax expenditures
are reviewed less frequently than direct expenditures once they
are put in place. This can offer taxpayers greater certainty,
but it can also result in tax expenditures remaining a part of
the tax code without demonstrating any public benefit. Second,
there is generally no control over the amount of revenue losses
associated with any given tax expenditure. Finally, once
enacted, it takes a two-thirds vote to rescind an existing tax
expenditure absent a sunset date. SB1437 contains a 5 year
sunset.
4. 529 versus ESA. Although similar, there are key differences
between utilizing an ESA versus a 529 account (also known as a
as a ScholarShare College Savings Plan) tool for saving for
education. An ESA has both a yearly contribution limit and
income limits, a 529 has no yearly contribution limit or an
income limit, but there is a maximum account balance limit of
$475,000. Balances in an ESA must be disbursed on qualified
education expenses by the time the beneficiary is 30 years old
or given to another family member below the age of 30 in order
to avoid taxes and penalties; there is no age limit for 529
plans. An ESAs allows withdrawing the money tax free for
qualified elementary and secondary school expenses, whereas a
529 plan does not.
Earnings from both types of accounts are not subject to federal
and state tax when used for the qualified education expenses of
the designated beneficiary, such as tuition, fees, books, as
well as room and board. Contributions to both accounts are not
deductible.
5. 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
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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.
6. Private School Subsidy. Unlike a 529 College Savings plan,
an ESA 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 be used to pay for
private school tuition. The Committee may wish consider whether
subsidizing private education is an appropriate use of public
funds.
7. Above and below the line deductions. An above-the-line
deduction is a deduction that allows a taxpayer to subtract
amounts from gross income when calculating their AGI. If the
deduction is taken above the line, it is used to determine the
taxpayer's AGI. An above-the-line deduction can be taken by any
taxpayer regardless of whether the taxpayer itemizes. Moreover,
an above-the-line deduction reduces AGI, and having a smaller
AGI can lower many subsequent calculations which will further
reduce taxes. As a result, above-the-line deductions are more
advantageous than those taken below the line. Once AGI is
determined, a taxpayer can either itemize deductions or take the
standard deduction, whichever is greater. Once itemized
deductions exceed the standard deduction, other smaller
below-the-line deductions, such as miscellaneous expenses, can
be applied to increase tax savings. However, in order to take
advantage of a miscellaneous below-the-line deduction, total
expenses must exceed 2% of AGI and all deductions in total must
exceed the standard deduction. Currently, less than one-half of
California individuals itemize their deductions.
8. Reverse nonconformity. California law does not
automatically conform to changes to federal tax law, except
under specified circumstances. Instead, the Legislature must
affirmatively conform to federal changes. Generally, when the
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federal government changes its tax laws, California catches up
by enacting its own legislation the following year to reduce
differences between the two codes, thereby easing the tax
preparation burden on taxpayers, tax preparers, and the
Franchise Tax Board. Currently, under federal tax law there is
no above-the-line deduction for contributions to an ESA, or for
K-12 education expenses. Thus, if SB 1437 is enacted taxpayers
would be entitled to a deduction for state tax purposes, but not
for federal tax purposes.
9. Let's get clear. Several terms in the bill may need to be
clarified. For example, it is unclear if "household income," as
defined in this provision, would include the AGI of each member
of the household or only the AGI of the qualified taxpayer. The
Committee may wish to consider amending the bill to reduce
potential disagreements between taxpayers and FTB.
Support and
Opposition (5/5/16)
Support : California Association of Private School
Organizations; California Catholic Conference.
Opposition : California Federation of Teachers; California Tax
Reform Association; California Teachers Association.
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