Tax Provisions With Education Expense Assistance: The Alternatives

By: Julianne Jones and Li Wang

Julianne Jones is a professor of practice at the George W. Daverio School of Accountancy at the University of Akron, Ohio. Li Wang is a professor of accounting at the school.

In this article, Jones and Wang examine ways that tax provisions could be improved to make college education more affordable.

On August 24, 2022, the White House announced a student debt relief plan to provide up to $20,000 in one-time student debt cancellation for low- and middle-income taxpayers.¹ According to the Congressional Budget Office, this plan would eliminate roughly $430 billion of the $1.6 trillion in outstanding student debt. The plan is certainly beneficial for many U.S. citizens, but it has received mixed views from the media, politicians, and taxpayers. The plan is intended to provide relief to low- and middle-income taxpayers with taxable income less than $125,000 (single) or $225,000 (married filing jointly), but some have expressed concerns. These concerns include a perceived unfairness to graduates who have paid off their student loans or graduated without student debt and that, because the plan is not forward-looking, it provides no relief for current or future students.

A lawsuit filed by six states (Arkansas, Iowa, Kansas, Missouri, Nebraska, and South Carolina) argues that the Biden administration bypassed congressional authority and that the plan threatens future tax revenues and money earned by state entities that invest in or service student loans. The lawsuit was dismissed, but the states appealed, and the Eighth Circuit issued an injunction barring the Department of Education from canceling student loan debt. The Biden administration asked the Supreme Court to intervene. The Court is scheduled to hear the case on February 28.

Education is vital for innovation and the economy. The affordability of higher education is an important issue. College tuition has increased substantially over the years, and student loans have become a significant financial burden for many. According to the Trends in College Pricing and Student Aid 2022 published by the College Board, average tuition and fees increased from $4,870 to $10,940 (2.25 times) at public four-year institutions, and from $21,860 to $39,400 (1.8 times) at private, nonprofit four-year institutions between 1992 and 2022 after adjusting for inflation.² In 2020, 51 percent of bachelor’s degree recipients from public four-year institutions graduated with average federal debt of $21,400 per borrower. These figures are 53 percent and $22,600 per borrower for private institutions.

While the controversial student debt relief plan is stuck in a legal battle, existing tax provisions can be improved to make college education more affordable.

Option No. 1: Increase the Employer Educational Assistance Exclusion Amount

IRC section 127 allows employees to exclude on their tax returns up to $5,250 per year of education costs paid or reimbursed by their employers. This provides benefits for both employees and employers. It enables employers to upskill their employees and offer tax-free educational assistance to employees as a benefit to attract and retain talent. Employers can deduct it as an expense on their tax returns. Employees can receive tax-free assistance and gain advanced knowledge and skills to remain competitive in the job market.

Proposal for Improvement

The $5,250 exclusion amount in section 127 has not been adjusted for inflation since 1986. We propose that this amount be indexed to inflation, like those of other tax provisions, such as the standard deduction. In 1986 section 127 increased the exclusion amount from $5,000 (enacted in 1984) to $5,250. The average cost of four-year undergraduate postsecondary tuition and fees in 1985-1986 was approximately $6,733.³ As such, $5,250 was in alignment with the college costs at that time. Based on the initial enactment, it seemed that the government was aiming for the exclusion amount to be close to the cost of a four-year college education. Since this amount has not been indexed for inflation for over 30 years, it is out of line with the cost of education. According to the National Center for Education Statistics (NCES), the average cost of four-year undergraduate tuition and fees for 2021 is $16,618. Tuition has increased substantially over the past 30 years; however, the employer exclusion amount has not been indexed for inflation.⁴ Congress can revise this IRC section to allow this provision to be indexed for inflation, like other provisions in the code.

Updating the exclusion amount would provide immediate benefits for students. Using the Social Security cost of living adjustment percentages to index the exclusion amount for inflation to 2023, the employer exclusion amount would be $14,281.⁵ This would be comparable to the average cost of college tuition and fees ($16,618 in 2021, according to the NCES’s latest report). Unlike the proposed student debt relief plan, this provision provides educational assistance for current and future students. It is forward-looking and strategically important for U.S. innovation, productivity, and the economy.

Many employers have used section 127. According to the Statista research department, 47 percent of employers offered undergraduate or graduate school tuition assistance to their employees in 2020.⁶ This tax provision can benefit taxpayers substantially, especially if it is adjusted for inflation.

Option No. 2: Increase the Student Loan Interest Deduction Amount and Phaseout Limits

Under IRC section 221, taxpayers can deduct interest paid on student loans up to $2,500. This deduction, however, has significant limitations. First, it cannot be taken by married taxpayers if they file separate returns (MFS provision). Second, the deduction is capped at $2,500 and the cap has not been adjusted for inflation, even though the associated phaseout limits have been adjusted. Third, the deduction is phased out based on adjusted gross income. For instance, a single taxpayer will be phased out of the deduction whose AGI is over $85,000 in 2021.⁷ The phaseout limits are not in line with the limits of other federal student loan provisions.

Proposals for Improvement

• Because the $2,500 student loan interest deduction has not been indexed for inflation, we propose that the amount be updated. Using the Social Security COLA percentages as the adjustment for inflation, the deduction amount would be $4,301 for 2023.
• Also, the MFS provision should be removed. Many married couples are now both working, and filing singly can help them achieve a better overall tax outcome.
• Finally, the phaseout threshold should be increased to align with the other student loan provisions. For instance, the proposed student debt relief plan applies to single taxpayers whose AGI is under $125,000.⁸ The student loan interest deduction phaseout limitation should match that amount.

Section 221 is widely used by taxpayers. According to the IRS’s estimate, over 10.1 million returns were filed claiming the student loan interest deduction for a total of $7.8 billion in 2020.⁹ However, there remains room for improvement. According to the IRS’s estimate, student loan interest paid in 2019 was over $48 billion,¹⁰ but only $14 billion was claimed for deduction.¹¹ Taxpayers paid much more student loan interest than they could deduct. The proposed improvements to index the student loan deduction for inflation, eliminate the MFS provision, and increase the phaseout limits can expand the deduction and would provide immediate benefits for current and future students to alleviate their college debt burdens.

Related Legislative Proposals

H.R. 5359, The DEBT Act of 2019

This bill was introduced on December 6, 2019, to the House Ways and Means Committee.¹² The bill amends sections 127 and 221 by expanding the exclusion of employer-provided educational assistance and the availability of student loan interest deductions. It proposed to:

• apply the education exclusion amount when an employer pays the student loan of the employee (principal or interest);
• increase employer exclusion amount from $5,250 to $10,000;
• increase student loan interest deduction cap from $2,500 to $5,000; and
• increase the section 221 student loan interest deduction phaseout limits from $15,000 ($30,000 for a joint return) to $85,000 ($115,000 for a joint return).

This bipartisan bill died in Congress without a vote. It was revived in H.R. 902 and introduced in 2021 but again died without a vote.¹³

S. 1802, The Upskilling and Retraining Assistance Act

This bipartisan bill was introduced in the Senate on May 25, 2021.¹⁴ It proposed to make two changes to section 127.¹⁵ The first was to enact an emergency expansion of the tax exclusion from $5,250 to $12,000 for the next two years. This would adjust the exclusion to account for the last three decades of inflation, assisting employers in meeting the needs of their workers as they grapple with the impacts of COVID-19 on their business. The second change would have expanded the tax exclusion to cover the cost of education-related tools and technology. This would include hand tools, construction equipment, computers and software, and other items related to the costs of a worker completing an education program.

The expansion of the tax exclusion from $5,250 to $12,000 would have brought the exclusion amount closer to the current tuition cost. Because it was an emergency expansion in the context of COVID-19, it was only a potential short-term solution. This bipartisan bill died in Congress without a vote. It was revived with S. 4411 and introduced in 2021, but again died without a vote.¹⁶

Conclusion

Looking at history across countries, economic performance is often driven by productivity, and productivity is fueled by technological advancement and innovation. High-quality education plants the seed for technological advancement and innovation. It is strategically important for the United States to continue its investment in higher education and prepare its citizens with advanced knowledge and skills to remain competitive. This should be a top priority for any nation. The cost of college education has increased considerably over the years. The two tax provisions discussed have not been updated to match these increases and no longer achieve their original purposes.

Indexing the two provisions for inflation, as with other tax provisions, is rational and reasonable. It is less controversial than the proposed student debt relief plan. Also, unlike the proposed plan, these provisions provide educational assistance for current and future students. They are forward-looking and strategically important for the United States.

The U.S. population growth rate and the U.S. labor force participation rate have been trending down since the 1970s and this will continue until at least 2030, according to the U.S. Bureau of Labor Statistics.¹⁷ Employers in some industry sectors are experiencing increasing challenges in recruiting and retaining qualified workers. The revisions proposed in this article to the existing tax provisions will not only help make college education more affordable but also provide employers with a more useful tool to increase skills in the workforce and attract and retain talent.

FOOTNOTES

¹ White House, “Fact Sheet: President Biden Announces Student Loan Relief for Borrowers Who Need It Most” (Aug. 24, 2022).

² Jennifer Ma and Matea Pender, “Trends in College Pricing and Student Aid 2022,” College Board (2022).

³ NCES, “Table 330.10. Average Undergraduate Tuition, Fees, Room, and Board Rates Charged for Full-Time Students in Degree-Granting Postsecondary Institutions, by Level and Control of Institution: Selected Years, 1963-64 Through 2020-21.”

⁴ Demos, “When Congress Went to College: Comparing Tuition Then and Now at Our Elected Officials’ Alma Maters” (Feb. 15, 2018).

⁵ Social Security Administration, “Cost-of-Living Adjustment (COLA) Information for 2023.”

⁶ Statista, “Percent of U.S. Employers Offering Education Benefits to Employees 2019” (Jan. 9, 2023).

⁷ IRS, “Tax Benefits for Education,” Publication 970 (Jan. 20, 2023). Single taxpayers whose AGI is over $85,000 for 2021 are phased out of the student loan interest deduction.

⁸ White House, supra note 1.

⁹ IRS, “Individual Income Tax Returns Line Item Estimates, 2020,” Publication 4801 (Rev. 11-2022), at 23-24.

¹⁰ IRS, “2019 Individual Information Returns, Line Item Estimates,” Publication 5385 (Rev. 11-2021), at 65.

¹¹ IRS, “Individual Income Tax Returns Line Item Estimates, 2019,” Publication 4801 (Rev. 12-2021), at 24.

¹² H.R. 5359, 116th Cong. (2019).

¹³ H.R. 902, 117th Cong. (2021).

¹⁴ S. 1802, 117th Cong. (2021).

¹⁵ Office of Sen. Maggie Hassan, “Upskilling and Retraining Assistance Act” (May 25, 2021).

¹⁶ H.R. 4411, 117th Cong. (2021).

¹⁷ U.S. Bureau of Labor Statistics, “Projections Overview and Highlights, 2020-30” (Oct. 2021).