DESCRIPTION OF H.R. 7

(THE “EDUCATION SAVINGS

 AND SCHOOL EXCELLENCE ACT OF 1999”)

Scheduled for Markup

By the

HOUSE COMMITTEE ON WAYS AND MEANS

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

March 21, 2000

JCX-30-00
(i)

CONTENTS

Page

I. INTRODUCTION ................................................. 1

II. EDUCATION TAX INCENTIVES ................................... 2

A. Expand Education Savings Accounts ................................ 2

B. Allow Tax-Free Distributions From State and Private Education Programs . . . 6

C. Exclusion for Employer-Provided Educational Assistance . . . . . . . . . . . . . . . . 8

D. Liberalize Tax-Exempt Bond Arbitrage Rebate Exceptions for Public

School Construction Bonds ........................................ 9

E. Eliminate Tax on Awards under National Health Service Corps Scholarship

Program and the F. Edward Hebert Armed Forces Health Professions 

Scholarship and Financial Assistance Program . . . . . . . . . . . . . . . . . . . . . . . . . 11
1

 This document may be cited as follows: Joint Committee on Taxation, Description of

H.R. 7 (the “Education Savings and School Excellence Act of 1999”), (JCX-30-00), March 21,

2000.

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I. INTRODUCTION

This document,1

 prepared by the staff of the Joint Committee on Taxation, provides a

description of H.R. 7, the “Education Savings and School Excellence Act of 1999,” scheduled for

markup in the House Committee on Ways and Means.
2

 Education IRAs generally are not subject to Federal income tax, but are subject to the

unrelated business income tax (“UBIT”) imposed by section 511.

3

 An excise tax may be imposed under present law to the extent that excess contributions

above the $500 annual limit are made to an education IRA.

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II. EDUCATION TAX INCENTIVES

A. Expand Education Savings Accounts

Present Law

In general

Section 530 provides tax-exempt status to education individual retirement accounts

(“education IRAs”), meaning certain trusts (or custodial accounts) which are created or organized

in the United States exclusively for the purpose of paying the qualified higher education expenses

of a named beneficiary.2 Contributions to education IRAs may be made only in cash. Annual

contributions to education IRAs may not exceed $500 per designated beneficiary (except in cases

involving certain tax-free rollovers, as described below), and may not be made after the

designated beneficiary reaches age 18.3

 Moreover, an excise tax is imposed if a contribution is

made by any person to an education IRA established on behalf of a beneficiary during any

taxable year in which any contributions are made by anyone to a qualified State tuition program

(defined under sec. 529) on behalf of the same beneficiary.

Phaseout of contribution limit

The $500 annual contribution limit for education IRAs is phased out ratably for

contributors with modified adjusted gross income (“AGI”) between $95,000 and $110,000

(between $150,000 and $160,000 for joint returns). Individuals with modified AGI above the

phase-out range are not allowed to make contributions to an education IRA established on behalf

of any individual.

Treatment of distributions

Amounts distributed from an education IRA are excludable from gross income to the

extent that the amounts distributed do not exceed qualified higher education expenses of the

designated beneficiary incurred during the year the distribution is made (provided that a HOPE

credit or Lifetime Learning credit is not claimed with respect to the beneficiary for the same

taxable year). Distributions from an education IRA are generally deemed to consist of

distributions of principal (which, under all circumstances, are excludable from gross income) and

earnings (which may be excludable from gross income) by applying the ratio that the aggregate

amount of contributions to the account for the beneficiary bears to the total balance of the
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account. If the qualified higher education expenses of the student for the year are at least equal to

the total amount of the distribution (i.e., principal and earnings combined) from an education

IRA, then the earnings in their entirety are excludable from gross income. If, on the other hand,

the qualified higher education expenses of the student for the year are less than the total amount

of the distribution (i.e., principal and earnings combined) from an education IRA, then the

qualified higher education expenses are deemed to be paid from a pro-rata share of both the

principal and earnings components of the distribution. Thus, in such a case, only a portion of the

earnings are excludable (i.e., a portion of the earnings based on the ratio that the qualified higher

education expenses bear to the total amount of the distribution) and the remaining portion of the

earnings is includible in the distributee's gross income.

To the extent that a distribution exceeds qualified higher education expenses of the

designated beneficiary, an additional 10-percent tax is imposed on the earnings portion of such

excess distribution, unless such distribution is made on account of the death or disability of, or

scholarship received by, the designated beneficiary. The additional 10-percent tax also does not

apply to the distribution of any contribution to an education IRA made during the taxable year if

such distribution is made on or before the date that a return is required to be filed (including

extensions of time) by the beneficiary for the taxable year during which the contribution was

made (or, if the beneficiary is not required to file such a return, April 15th of the year following

the taxable year during which the contribution was made), provided that such distribution is

accompanied by the amount of income allocable to the contribution.

Present law allows tax-free transfers or rollovers of account balances from one education

IRA benefitting one beneficiary to another education IRA benefitting another beneficiary (as well

as redesignations of the named beneficiary), provided that the new beneficiary is a member of the

family of the old beneficiary. For this purpose, a “member of the family” means persons

described in paragraphs (1) through (8) of section 152(a)--e.g., sons, daughters, brothers, sisters,

nephews and nieces, certain in-laws--and any spouse of such persons or of the original

beneficiary.

Any balance remaining in an education IRA is deemed to be distributed within 30 days

after the date that the named beneficiary reaches age 30 (or, if earlier, within 30 days of the date

that the beneficiary dies).

Qualified higher 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. Moreover, the term

“qualified higher education expenses” includes certain room and board expenses for any period

during which the beneficiary is at least a half-time student. Qualified higher education expenses

include expenses with respect to undergraduate or graduate-level courses. In addition, qualified
4

 No reduction of qualified higher education expenses is required, however, for a gift,

bequest, devise, or inheritance.

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higher education expenses include amounts paid or incurred to purchase tuition credits (or to

make contributions to an account) under a qualified State tuition program, as defined in section

529, for the benefit of the beneficiary of the education IRA.

Qualified higher education expenses generally include only out-of-pocket expenses. Such

qualified higher education expenses do not include expenses covered by educational assistance

for the benefit of the beneficiary that is excludable from gross income. Thus, total qualified

higher education expenses are reduced by scholarship or fellowship grants excludable from gross

income under present-law section 117, as well as any other tax-free educational benefits, such as

employer-provided educational assistance that is excludable from the employee’s gross income

under section 127.4

Present law also provides that, if any qualified higher education expenses are taken into

account in determining the amount of the exclusion for a distribution from an education IRA,

then no deduction (e.g., for trade or business expenses deductible under sec. 162), or exclusion

(e.g., for expenses paid with interest on education savings bonds excludable under sec. 135), or

credit is allowed with respect to such expenses.

Eligible educational institution

Eligible educational institutions are defined by reference to section 481 of the Higher

Education Act of 1965. Such institutions generally are accredited post-secondary educational

institutions offering credit toward a bachelor's degree, an associate's degree, a graduate-level or

professional degree, or another recognized post-secondary credential. Certain proprietary

institutions and post-secondary vocational institutions also are eligible institutions. The

institution must be eligible to participate in Department of Education student aid programs.

Description of Proposal

Annual contribution limit

The proposal would increase the annual education IRA contribution limit to $2,000. 

Thus, aggregate contributions that could be made by all contributors to one (or more) education

IRAs established on behalf of any particular beneficiary would be limited to $2,000 for each year.

Qualified expenses

The proposal would expand the definition of qualified education expenses that may be

paid with tax-free distributions from an education IRA. Specifically, the definition of qualified

education expenses would be expanded to include “qualified elementary and secondary education
5

 Contributions made to education IRAs prior to the effective date of the proposal, (and

earnings thereon) could be used for distributions for qualified elementary and secondary

education expenses made after January 1, 2001. Thus, it would not be necessary for trustees of

education IRAs to keep separate accounts with respect to contributions made prior to the

effective date of the proposal and earnings thereon. 

6

 “Qualified higher education expenses” for purposes of education IRAs are defined by

reference to the definition of such expenses for purposes of qualified tuition programs (sec.

530(b)(2)(A)). Because the proposal modifies the definition of “qualified higher education

expenses” for purposes of qualified tuition programs (sec. 529(e)(3)), the definition of “qualified

higher education expenses” for education IRAs is also modified. 

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expenses,” meaning (1) tuition, fees, academic tutoring, special needs services, books, supplies,

and equipment (including computers and related software and services) incurred in connection

with the enrollment or attendance of the designated beneficiary as an elementary or secondary

student at a public, private, or religious school providing elementary or secondary education

(kindergarten through grade 12), and (2) room and board, uniforms, transportation, and

supplementary items and services (including extended-day programs) required or provided by

such a school in connection with such enrollment or attendance of the designated beneficiary.5

“Qualified elementary and secondary education expenses” also would include certain

homeschooling education expenses if the requirements of any applicable State or local law are

met with respect to such homeschooling.

Under the proposal, the definition of “qualified higher education expenses” would be

modified to mean expenses for tuition, fees, academic tutoring, special needs, services, books,

supplies, computer equipment (including related software and services), and other equipment

which are incurred in connection with the enrollment or attendance of the designated beneficiary

at an eligible educational institution.6

 The proposal would not change the definition of “qualified

higher education expenses” with respect to expenses for room and board.

Special needs beneficiaries

The proposal would also provide that, although contributions to an education IRA

generally may not be made after the designated beneficiary reaches age 18, contributions may

continue to be made to an education IRA in the case of a special needs beneficiary (as defined by

Treasury Department regulations). In addition, under the proposal, in the case of a special needs

beneficiary, a deemed distribution of any balance in an education IRA would not occur when the

beneficiary reaches age 30.

Contributions by persons other than individuals

The proposal would clarify that corporations and other entities (including tax-exempt

organizations) are permitted to make contributions to education IRAs regardless of the income of
7

 “Eligible educational institutions” are defined the same for purposes of education IRAs

and qualified State tuition programs.

8

 Distributions from qualified State tuition programs are treated as representing a pro-rata

share of the principal (i.e., contributions) and accumulated earnings in the account.

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the corporation or entity during the year of the contribution.

Effective Date

The provisions modifying education IRAs would be effective for taxable years beginning

after December 31, 1999. 

B. Allow Tax-Free Distributions From State and Private Education Programs

Present Law

Section 529 provides tax-exempt status to "qualified State tuition programs," meaning

certain programs established and maintained by a State (or agency or instrumentality thereof)

under which persons may (1) purchase tuition credits or certificates on behalf of a designated

beneficiary that entitle the beneficiary to a waiver or payment of qualified higher education

expenses of the beneficiary, or (2) make contributions to an account that is established for the

purpose of meeting qualified higher education expenses of the designated beneficiary of the

account (a “savings account plan”). The term "qualified higher education expenses" generally

has the same meaning as does the term for purposes of education IRAs (as described above) and,

thus, includes expenses for tuition, fees, books, supplies, and equipment required for the

enrollment or attendance at an eligible educational institution7

, as well as certain room and board

expenses for any period during which the student is at least a half-time student.

No amount is included in the gross income of a contributor to, or beneficiary of, a

qualified State tuition program with respect to any distribution from, or earnings under, such

program, except that (1) amounts distributed or educational benefits provided to a beneficiary

(e.g., when the beneficiary attends college) are included in the beneficiary's gross income (unless

excludable under another Code section) to the extent such amounts or the value of the

educational benefits exceed contributions made on behalf of the beneficiary, and (2) amounts

distributed to a contributor (e.g., when a parent receives a refund) are included in the

contributor's gross income to the extent such amounts exceed contributions made on behalf of the

beneficiary.8

A qualified State tuition program is required to provide that purchases or contributions
9

 Sections 529(c)(2), (c)(4), and (c)(5), and section 530(d)(3) provide special estate and

gift tax rules for contributions made to, and distributions made from, qualified State tuition

programs and education IRAs.

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only be made in cash.9

 Contributors and beneficiaries are not allowed to directly or indirectly

direct the investment of contributions to the program (or earnings thereon). The program is

required to maintain a separate accounting for each designated beneficiary. A specified

individual must be designated as the beneficiary at the commencement of participation in a

qualified State tuition program (i.e., when contributions are first made to purchase an interest in

such a program), unless interests in such a program are purchased by a State or local government

or a tax-exempt charity described in section 501(c)(3) as part of a scholarship program operated

by such government or charity under which beneficiaries to be named in the future will receive

such interests as scholarships. A transfer of credits (or other amounts) from one account

benefitting one designated beneficiary to another account benefitting a different beneficiary is

considered a distribution (as is a change in the designated beneficiary of an interest in a qualified

State tuition program), unless the beneficiaries are members of the same family. For this

purpose, the term "member of the family" means persons described in paragraphs (1) through (8)

of section 152(a)--e.g., sons, daughters, brothers, sisters, nephews and nieces, certain in-laws--

and any spouse of such persons or of the original beneficiary. Earnings on an account may be

refunded to a contributor or beneficiary, but the State or instrumentality must impose a more than

de minimis monetary penalty unless the refund is (1) used for qualified higher education

expenses of the beneficiary, (2) made on account of the death or disability of the beneficiary, or

(3) made on account of a scholarship received by the designated beneficiary to the extent the

amount refunded does not exceed the amount of the scholarship used for higher education

expenses.

To the extent that a distribution from a qualified State tuition program is used to pay for

qualified tuition and related expenses (as defined in sec. 25A(f)(1)), the distributee (or another

taxpayer claiming the distributee as a dependent) may claim the HOPE credit or Lifetime

Learning credit under section 25A with respect to such tuition and related expenses (assuming

that the other requirements for claiming the HOPE credit or Lifetime Learning credit are satisfied

and the modified AGI phaseout for those credits does not apply).

Description of Proposal

Qualified tuition program

The proposal would expand the definition of “qualified tuition program” to include

certain prepaid tuition programs established and maintained by one or more eligible educational

institutions (which may be private institutions) that satisfy the requirements under section 529

(other than the present-law State sponsorship rule). In the case of a qualified tuition program

maintained by one or more private educational institutions, persons would be able to purchase

tuition credits or certificates on behalf of a designated beneficiary (as described in section
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529(b)(1)(A)(i)), but would not be able to make contributions to a savings account plan

(described in section 529(b)(1)(A)(ii)).

Exclusion from gross income

Under the proposal, distributions from qualified State tuition programs and from qualified

tuition programs established and maintained by an entity other than a State or agency or

instrumentality thereof would be excludable from gross income to the extent that the distribution

is used to pay for qualified higher education expenses (and provided that a HOPE credit or

Lifetime Learning credit is not claimed with respect to the beneficiary for the same taxable year).

As under present law with respect to education IRAs, if any qualified higher education

expenses are taken into account in determining the amount of the exclusion for a distribution

from a qualified tuition program, then no deduction (e.g., for trade or business expenses

deductible under sec. 162), or exclusion (e.g., for expenses paid with interest on education

savings bonds excludable under sec. 135), or credit would be allowed with respect to such

expenses.

Definition of qualified higher education expenses

Under the proposal, the definition of “qualified higher education expenses” would be

modified to mean expenses for tuition, fees, academic tutoring, special needs, services, books,

supplies, computer equipment (including related software and services), and other equipment

which are incurred in connection with the enrollment or attendance of the designated beneficiary

at an eligible educational institution. The proposal would not change the definition of “qualified

higher education expenses” with respect to expenses for room and board.

Effective Date

The proposal would be effective for taxable years beginning after December 31, 1999.

C. Exclusion for Employer-Provided Educational Assistance

Present Law

Educational expenses paid by an employer for its employees are generally deductible to

the employer.

Employer-paid educational expenses are excludable from the gross income and wages of

an employee if provided under a section 127 educational assistance plan or if the expenses

qualify as a working condition fringe benefit under section 132. Section 127 provides an

exclusion of $5,250 annually for employer-provided educational assistance. The exclusion does

not apply to graduate courses. The exclusion for employer-provided educational assistance
10 These rules also apply in the event that section 127 expires and is not reinstated. 

11 In the case of an employee, education expenses (if not reimbursed by the employer)

may be claimed as an itemized deduction only if such expenses, along with other miscellaneous

deductions, exceed two percent of the taxpayer's AGI. The two-percent floor limitation is

disregarded in determining whether an item is excludable as a working condition fringe benefit. 

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expires with respect to courses beginning after December 31, 2001.

In order for the exclusion to apply, certain requirements must be satisfied. The

educational assistance must be provided pursuant to a separate written plan of the employer. The

educational assistance program must not discriminate in favor of highly compensated employees.

In addition, not more than 5 percent of the amounts paid or incurred by the employer during the

year for educational assistance under a qualified educational assistance plan can be provided for

the class of individuals consisting of more than 5-percent owners of the employer (and their

spouses and dependents).

Educational expenses that do not qualify for the section 127 exclusion may be excludable

from income as a working condition fringe benefit.10 In general, education qualifies as a working

condition fringe benefit if the employee could have deducted the education expenses under

section 162 if the employee paid for the education. In general, education expenses are deductible

by an individual under section 162 if the education (1) maintains or improves a skill required in a

trade or business currently engaged in by the taxpayer, or (2) meets the express requirements of

the taxpayer's employer, applicable law or regulations imposed as a condition of continued

employment. However, education expenses are generally not deductible if they relate to certain

minimum educational requirements or to education or training that enables a taxpayer to begin

working in a new trade or business.11

Description of Proposal

The proposal would permanently extend the present-law exclusion for employer-provided

educational assistance.

Effective Date

The proposal would be effective on the date of enactment. 

D. Liberalize Tax-Exempt Bond Arbitrage Rebate Exceptions

for Public School Construction Bonds

Present Law

Interest on debt incurred by States or local governments is excluded from income if the
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proceeds of the borrowing are used to carry out governmental functions of those entities or the

debt is repaid with governmental funds (sec. 103). Like other activities carried out and paid for

by States and local governments, the construction, renovation, and operation of public schools is

an activity eligible for financing with the proceeds of tax-exempt bonds.

The Federal income tax does not apply to the income of State and local governments that

is derived from the exercise of an essential governmental function. To prevent these tax-exempt

entities from issuing more tax-exempt bonds than is necessary for the activity being financed or

from issuing such bonds earlier than necessary, the Code includes arbitrage restrictions limiting

the ability to profit from investment of tax-exempt bond proceeds. In general, arbitrage profits

may be earned only during specified periods (e.g., defined “temporary periods”) before funds are

needed for the purpose of the borrowing or on specified types of investments (e.g., “reasonably

required reserve or replacement funds”). Subject to limited exceptions, profits that are earned

during these periods or on such investments must be rebated to the Federal Government.

The Code includes three exceptions applicable to education-related bonds. First, issuers

of all types of tax-exempt bonds are not required to rebate arbitrage profits if all of the proceeds

of the bonds are spent for the purpose of the borrowing within six months after issuance. In the

case of governmental bonds (including bonds to finance public schools) the six-month

expenditure exception is treated as satisfied if at least 95 percent of the proceeds is spent within

six months and the remaining five percent is spent within 12 months after the bonds are issued.

Second, in the case of bonds to finance certain construction activities, including school

construction and renovation, the six-month period is extended to 24 months for construction

proceeds. Arbitrage profits earned on construction proceeds are not required to be rebated if all

such proceeds (other than certain retainage amounts) are spent by the end of the 24-month period

and prescribed intermediate spending percentages are satisfied.

Third, governmental bonds issued by “small” governments are not subject to the rebate

requirement. Small governments are defined as general purpose governmental units that issue no

more than $5 million of tax-exempt governmental bonds in a calendar year. The $5 million limit

is increased to $10 million if at least $5 million of the bonds are used to finance construction of

public schools.

Description of Proposal

The additional amount of governmental bonds for public schools construction that small

governmental units may issue without being subject to the arbitrage rebate requirement would be

increased from $5 million to $10 million. Thus, these governmental units could issue up to $15

million of governmental bonds in a calendar year, provided that at least $10 million of the bonds

were used to finance construction of public schools.
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Effective Date

The proposal would be effective for obligations issued after December 31, 1999.

E. Eliminate Tax on Awards under National Health Service Corps Scholarship

Program and the F. Edward Hebert Armed Forces Health Professions 

Scholarship and Financial Assistance Program

Present Law

Section 117 excludes from gross income qualified scholarships received by an individual

who is a candidate for a degree and used for tuition and fees required for the enrollment or

attendance (or for fees, books, supplies, and equipment required for courses of instruction) at a

primary, secondary, or post-secondary educational institution. The tax-free treatment provided by

section 117 does not extend to scholarship amounts covering regular living expenses, such as

room and board. In addition to the exclusion for qualified scholarships, section 117 provides an

exclusion from gross income for qualified tuition reductions for certain education provided to

employees (and their spouses and dependents) of certain educational organizations.

Section 117(c) specifically provides that the exclusion for qualified scholarships and

qualified tuition reductions does not apply to any amount received by a student that represents

payment for teaching, research, or other services by the student required as a condition for

receiving the scholarship or tuition reduction.

The National Health Service Corps Scholarship Program (the “NHSC Scholarship

Program”) and the F. Edward Hebert Armed Forces Health Professions Scholarship and

Financial Assistance Program (the “Armed Forces Scholarship Program”) provide education

awards to participants on condition that the participants provide certain services. In the case of

the NHSC Program, the recipient of the scholarship is obligated to provide medical services in a

geographic area (or to an underserved population group or designated facility) identified by the

Public Health Service as having a shortage of health-care professionals. In the case of the Armed

Forces Scholarship Program, the recipient of the scholarship is obligated to serve a certain

number of years in the military at an armed forces medical facility. Because the recipients of

scholarships in these programs are required to perform services in exchange for the education

awards, the awards used to pay higher education expenses are taxable income to the recipient.

Description of Proposal

The proposal would provide that amounts received by an individual under the NHSC

Scholarship Program and the Armed Forces Scholarship Program are eligible for tax-free

treatment as qualified scholarships under section 117, without regard to any service obligation by

the recipient. As with other qualified scholarships under section 117, the tax-free treatment

would not apply to amounts received by students for regular living expenses, including room and
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board.

Effective Date

The proposal would be effective for amounts received in taxable years beginning after

December 31, 1993.