Scholarships and Educational Expenses, written by Carla Neeley Freitag, Esq., and Lisa Marie Starczewski, Esq., contains a detailed analysis and discussion of the income tax treatment of educational expenses and related expenses. It examines the rules regarding scholarships, fellowship grants, and other educational receipts under §117 of the Internal Revenue Code and employer-provided educational assistance under §127.
This Portfolio examines educational expenses that fall within the definition of “qualified scholarships” or “qualified tuition reductions” and discusses the exclusions that impact taxable income. Gross income does not include any amount received as a qualified scholarship by an individual taxpayer who is a candidate for degree at an educational institution, and it does not include the amount of a reduction in tuition provided to employees of certain organizations for education below the graduate level.
Scholarships and Educational Expenses discusses information reporting requirements for higher education tuition and related expenses as well as the provision related to the forgiveness of student loans. It examines qualified prepaid tuition programs that allow taxpayers to save for higher education in a tax-free savings account and analyzes another tax-free savings account, the Coverdell education savings account, which can be used for both higher education and secondary education expenses.
In addition, the Portfolio analyzes the two credits applicable to higher education tuition: the Hope scholarship credit and the Lifetime Learning credit. The deduction for interest on certain educational loans and the penalty-free withdrawal from individual retirement accounts for higher education expenses are discussed in detail.
In addition, this Portfolio discusses other incentives relevant to educational expenses, including deductions taken as an expense of trade or business under §162, qualified tuition plans under §529, and education tax credits.
Scholarships and Educational Expenses allows you to benefit from:
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Detailed Analysis
I. Introduction
II. Exclusion of Scholarships, Fellowships, and Other Receipts for Education
A. Introduction
B. Historical Perspective
1. Prior to 1954
2. 1954–1986
a. The 1954 Code
b. Amendment in 1980
c. The Deficit Reduction Act of 1984
3. The 1986 Code
C. Current Law
D. Section 117(a) Exclusion for Qualified Scholarships
1. Definition of “Qualified Scholarship”
a. In General
b. Definition of Scholarship or Fellowship Grant
(1) In General
(2) Bingler - The Quid Pro Quo Test
(a) In General
(b) Pre-1986 Case Law
(3) Employer-Employee Relationship
(b) Grants by Private Foundations
(4) Athletic Scholarships
(5) Payments of “Prizes” Denominated as Scholarships
(6) Self-Employment Taxes
c. Definition of Qualified Tuition and Related Expenses
2. Definition of Degree Candidate
3. Definition of Educational Organization
b. Teaching Hospitals/“Apprentice” Work
4. Section 117(c) Exception from Exclusion for Payments for Services
b. Health Professionals
c. Grants to Faculty Members/Students
d. Payments by or for the Benefit of Governmental Units
e. Employment Tax Issues
5. Recordkeeping Requirements
6. Requirements for Obtaining Private Rulings
E. Qualified Tuition Reduction Plans
1. Section 117(d)
2. Pre-1986 Case Law
F. Miscellaneous Exclusions Related to Education
1. Section 127
2. Section 132
3. Section 135
4. Christa McAuliffe Fellows
G. Interrelationship of 117 and 74 and 102
III. Deduction of Educational Expenses Under 162
1. Summary of Requirements for Deduction
2. “Education” Defined
3. Items Eligible for Deduction
4. Important Considerations Concerning Case Law
1. Development of the Law
a. Before 1958
b. The 1958 Regulation
c. The 1967 Revision
2. Present Validity of Cases and Rulings Decided Under Prior Law
C. Criteria for Deduction
1. Introduction
2. Section 162
a. Trade or Business
(1) Established Trade or Business vs. Preparation to Enter New Trade or Business
(2) Temporary Cessation vs. Abandonment of Trade or Business
b. Required Relationship Between Trade or Business and Expense
c. “Ordinary” and “Necessary”
3. Regs. 1.162-5
a. Summary of Requirements
b. Nondeductible Educational Expenditures
(1) Nature of Disqualified Expenditures in General
(2) Minimum Educational Requirements for Qualification in Present Trade or Business
(b) Change in Minimum Educational Requirements After Employment
(c) Change in Employment
(d) Individual Employed Prior to Satisfying Minimum Educational Requirements
(i) Apprenticeships
(ii) Employment Subject to Condition
(e) Special Rules for Educational Institutions
(3) Qualification for New Trade or Business
(b) Comparison Test
(i) Comparison of Taxpayer's Qualifications Before and After Education
(A) Identification of Tasks and Activities
(B) Apprenticeships
(C) Overlapping Tasks and Duties
(D) Bachelor's Degree
(E) Guidance from State Law
(F) Actual Commencement of New Trade or Business
(G) Specific Trades or Businesses within General Field
(H) Generalist to Specialist within Same Trade or Business
(ii) Significance of Noneducational Requirements to Qualification for New Trade or Business
(iii) Significance of Taxable Year in Determining Effect of Program of Study
(iv) Deductibility of Particular Courses within Program of Study
(A) Degree Programs
(B) Other Programs of Study
(c) New Trade or Business vs. Change of Duties
(i) “Change of Duties” Rule
(ii) Teaching and Related Duties
(A) Special Rule
(B) Application of Special Rule
(C) Preferential Treatment under Special Rule
(iii) Application to Employees Other Than Teachers
(d) Objective Standard
(i) Taxpayer Does Not Intend to Engage in the New Trade or Business
(ii) Education Recommended, Encouraged, or Required by Employer
(iii) New Trade or Business Not Economically Feasible for Taxpayer to Pursue
c. The Qualifying Tests
(2) Maintaining or Improving Skills Required for Present Employment or Trade or Business
(a) General Considerations
(b) Trade or Business Skills
(c) Education
(d) Relationship Between Education and Skills
(3) Meeting Express Requirements for Retention of Established Employment Relationship, Status, or Compensation
(b) Strict Construction of Terms
(c) Contexts for Determining Educational Requirements
d. Validity of Regs. 1.162-5
D. Limitations on Deduction of Educational Expenses
1. Limitations on Deduction of Travel Expenses Associated with Education
a. Travel as a Form of Education
(1) Deduction Disallowed for Taxable Years Beginning After 1986
(2) Prior Law: Taxable Years Beginning Before 1987
b. Travel Expenses Incident to Obtaining Education
(a) Primary Purpose Test
(b) Temporarily vs. Indefinitely Away from Home
(c) Travel Expenses of Spouses and Others
(2) Substantiation of Travel Expenses
(3) 50% Limitation on Deduction of Meals
(4) Foreign Travel Not Allocable to Trade or Business
c. Local Transportation Expenses Incident to Obtaining Education
2. Recipients of Tax-Exempt Educational Assistance from the Veterans’ Administration
3. Recipients of Scholarships and Other Excludible Educational Assistance
E. Tax Returns and Compliance
1. Form 1040
2. Substantiation
3. Penalties
IV. Qualified Tuition Programs
Introductory Material
A. In General
B. Definitions
C. Eligibility Requirements for Qualified Tuition Programs
D. Permissible Uses of Contributions
E. Former Penalties on Refunds
1. In General
2. Required Practices and Procedures for Identifying and Collecting Penalties
a. Distributions Must Be Treated as Payments of Qualified Higher Education Expenses
b. Penalty Collected on All Other Distributions
c. Refunds of Penalties
d. Documentation of Amounts Refunded and Not Used for Qualified Higher Education Expenses
e. Procedures for Collecting Penalties
F. Reporting Requirements
1. Return Filed with the IRS
2. Statement Furnished to the Distributee
3. Reports Between 529 Programs
G. Tax Treatment of Distributions
2. Rollover Distributions
3. Additional Tax
4. Computing Earnings
a. Amount of Earnings in a Distribution
b. Adjustment for Certain Pre-1999 Distributions and Earnings
c. Examples
5. Change in Designated Beneficiaries
6. Aggregation of Accounts
H. Estate, Gift and Generation-Skipping Transfer Tax Rules
1. Contributions After August 20, 1996, and Before August 6, 1997
2. Contributions After August 5, 1997
a. Contributions That Exceed the Annual Exclusion Amount
b. Change of Designated Beneficiary or Rollover
3. Treatment of Estates of Decedents Dying After August 20, 1996, and Before June 9, 1997
4. Treatment of Estates of Decedents Dying After June 8, 1997
I. Advance Notice of Proposed Rulemaking
V. Coverdell Education Savings Accounts
B. Qualified Education Expenses
1. Expenses for Higher Education
2. Expenses for Secondary Education
C. Eligible Education Institution
D. Contribution Limitations
E. Distributions
F. Transfers Upon Divorce or Death
G. Estate, Gift and Generation-Skipping Transfer Tax Rules
H. Other Rules
VI. Tax Credits for Higher Education
B. The Hope Scholarship and American Opportunity Credits
C. The Lifetime Learning Credit
D. Definitions and Rules Applicable to Both Credits
1. Eligible Educational Institution
2. Qualified Tuition and Related Expenses
3. Academic Period
4. Phase-Out Rules
5. Timing Rules
6. Rules Applicable to Spouses and Dependents
7. Adjustments to Otherwise Qualifying Tuition and Related Expenses
b. Relationship Between 117 and 25A Credit
8. Refunds of Expenses and Receipt of Educational Assistance in Later Tax Year
9. Recapture Provisions
10. Limitation Based on Tax Liability
VII. Interest on Educational Loans
1. Treatment of Capitalized Interest and Certain Fees
2. Interest Payments Made During Periods When Not Required; Denial of Double Deduction
3. Third Party Payments; Legal Obligation.
B. Maximum Deductible Amount and Phase-Out Rules
C. Qualified Education Loan
2. Qualified Higher Education Expenses
3. Eligible Education Institution
4. Eligible Student
D. Pre-2002 60-Month Limitation
1. Deferments and Forbearances
2. Late Payments
3. Refinancings, Consolidated Loans, and Collapsed Loans
VIII. Penalty-Free Withdrawal from IRA
IX. Forgiveness of Student Loans
X. Deduction for Qualified Higher Education Expenses
B. Limitations
XI. Information Reporting Requirements
B. Who Must File
C. Content of Information Returns
D. Payee Statements
E. Penalty for Noncompliance
Working Papers
Finding Aid
Other Sources
Worksheet 1 IRS Pub. 970, Tax Benefits for Education (Excerpt - Highlights of Tax Benefits for Education)
Worksheet 2 IRS Publication 17, Your Federal Income Tax (Excerpt - Employee's Educational Expenses)
Worksheet 3 Flow Chart - Taxation of Scholarships and Fellowship Grants
Worksheet 4 Flow Chart - Requirements for Deduction
Worksheet 5 Sample Form 8863
Worksheet 6 Digest of Cases by Type of Education
Bibliography
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