Report to Congress on

Coordinating 

the American Opportunity Tax Credit 

and the Federal Pell Grant 

U.S. DEPARTMENT OF THE TREASURY

May 5, 2014

The American Opportunity Tax Credit (AOTC), enacted as part of the American Recovery and 

Reinvestment Act, was signed by the President in February 2009. The same law mandated that a study be 

undertaken by the Secretary of the Treasury and the Secretary of Education, to examine 1) how to 

coordinate the AOTC with the Federal Pell Grant Program to maximize their effectiveness; 2) how to 

expedite delivery of the AOTC; and 3) whether it was feasible to require community service as a 

condition of eligibility for receiving the credit. This Treasury report on the findings of the study by the 

Department of Treasury and the Department of Education answers that mandate. 
1

Executive Summary

The American Opportunity Tax Credit (AOTC), enacted as part of the American Recovery and 

Reinvestment Act (ARRA), was signed by the President in February 2009. The same law 

mandated that a study be undertaken by the Secretary of the Treasury and the Secretary of 

Education, or their delegates, to examine 1) how to coordinate the AOTC with the Federal Pell 

Grant Program to maximize their effectiveness; 2) how to expedite delivery of the AOTC; and 3) 

whether it was feasible to require community service as a condition of eligibility for receiving 

the AOTC.

1

 The AOTC was extended to tax years 2011 and 2012 as part of the Tax Relief, 

Unemployment Insurance Reauthorization and Job Creation Act of 2010 (TRUIRJCA) and 

through 2017 as part of the American Tax Relief Act of 2012 (ATRA). The President’s Fiscal

Year 2014 (FY2014) Budget has called on Congress to make the AOTC permanent. 

Summary of Findings:

1. How to coordinate the AOTC with the Federal Pell Grant Program to maximize their 

effectiveness? Some options include:

• Simplify the Financial Aid Formula and Remove the Asset Test. In 2009, the

Administration proposed legislation to simplify the formula for the Federal financial aid 

programs (including Pell Grants) by eliminating the question regarding contributions 

from savings and 14 other financial questions from the Free Application for Federal 

Student Aid (FAFSA). Removing these questions from the FAFSA would allow students 

to apply for aid using only the information found on their federal income tax forms. In 

combination with the current web-based IRS data retrieval tool, this option would make 

 1 The statutory language appears in an appendix to this study.
2

the process of applying for and receiving Federal student aid much simpler, fairer, and 

more accurate. 2

• Create Web Estimates of AOTC Eligibility. Under this option, students and their 

families would receive an estimate of their eligibility for an AOTC at the same time as 

they receive an estimate of their eligibility for Pell Grants and Federal loans. By showing

the possibility of receiving an AOTC alongside the value of a Pell Grant, students would 

have a better sense of the total level of Federal aid that they could expect to receive. 

• Improve Information Reporting. Under this option, information reporting on the Form 

1098-T – which colleges and universities provide to the Internal Revenue Service as well 

as to students and their families – would be improved to ensure that eligible students are 

able to claim the full amount of benefits to which they are entitled and to ensure that 

claimants are in compliance with law.

• Exclude Pell Grants from Taxable Income. Under this option, a student’s Pell Grant 

Award would be excluded from taxable income even if it is used for living expenses

(current law permits an exclusion if the Pell Grant is used for tuition and fees). This 

option would allow more low-income students to claim the AOTC for tuition and use the 

Pell Grant for living expenses, increasing the amount of scholarship aid provided lowincome students and making the calculation of the AOTC simpler.

2. How to expedite delivery of the AOTC? Some options include:

• Making the AOTC Advance-Refundable. This report considers the advantages and 

disadvantages of paying the AOTC in advance (that is, providing a refund of the tax 

 2 In their study of the complexity of Federal student aid, Dynarski and Clayton (2006) find that assets have little 

impact on the calculation of federal aid. The authors simulated the effect of dropping the asset test from the FAFSA 

and found that without an asset test, 86 percent of Pell grants would have been within $500 of the grant received 

with the asset test in place. 
3

credit prior to filing a tax return). The report finds that the limited advantages are 

outweighed by the disadvantages of this option. The report concludes that existing ways 

of delivering direct grant aid are better for delivering education subsidies in advance of 

tax filing to low-income students.

• Integrate Delivery of the Refundable Portion of the AOTC into the Title IV Delivery 

System. Under this option, an amount roughly equal to the refundable portion of the 

AOTC would be delivered to the student as a boost to their Pell Grant rather than as a 

refundable tax credit. The Pell Grant increase would be based on prior year tax data as 

provided on the FAFSA and would be administered by the Department of Education. A 

Pell “boost” would only be available for 4 years. The nonrefundable portion of the 

AOTC would not be changed. Alternatively, the savings from making the AOTC 

nonrefundable could be used to increase the Pell grant maximum award for all Pell 

recipients (however, some students would see the total amount of their Federal aid 

decline under this approach). 

3. Should Community Service Be a Condition of Eligibility for Receiving the AOTC?

• A Community Service Requirement Would Be Costly for the IRS and Higher 

Education Institutions to Administer and Might Not Serve Its Intended Purpose. 

This report offers a framework for administering a volunteer requirement for AOTC 

eligibility and enumerates the challenges that would need to be overcome to implement 

such a requirement. The report concludes that while technically possible, such a 

requirement would be very costly for educational institutions and the IRS to administer.
4

I. Introduction

The American Recovery and Reinvestment Act of 2009 (ARRA) dramatically increased Federal 

support for higher education by increasing education tax credits and Pell Grants. ARRA created 

the American Opportunity Tax Credit (AOTC) as an enhancement and a replacement for the 

Hope credit. The AOTC is currently available through 2017. The AOTC provides a tax credit of 

up to $2,500 per student and up to $1,000 of this amount is refundable. ARRA also provided 

supplemental funding to Pell Grants to fund the estimated cost of the increase in the maximum 

award in 2010 to $5,550.

For tax year 2009, 9.0 million tax returns claimed $15.8 billion in American Opportunity Tax 

Credits for an average tax credit of about $1,760.

3

 This level of education credits (including the 

lifetime learning credit) was over a $10 billion increase from the prior year. In addition, during 

FY2010 an estimated 8.9 million students received $36.5 billion in Pell Grant awards for an 

average award of $4,115.

4

 As with the tax credits, the current funding levels represent a 

landmark increase in Federal support for college scholarships. Over the last decade, the number 

of Pell recipients has more than doubled and the total dollar amount of Pell Grants received has 

quadrupled.

While there is some coordination between the tax incentives and outlay programs, ARRA 

mandated a study to determine 1) if coordination could be improved; 2) if delivery of the credit 

could be expedited; and 3) if it is feasible to require community service as a condition of 

eligibility for the credit.5,6

 To answer this mandate, Section II of this report describes the higher 

education market, including who is currently going to school and at what cost; Section III

describes current Federal support for higher education, both tax incentives and direct Federal 

student aid; Section IV describes the current level of coordination between Pell Grants and the 

 3 Estimates reflect tax filings as of December 2010. 4 U.S. Department of Education (2011), “FY 2012 Department of Education Justifications of Appropriation 

Estimates to the Congress: Student Financial Assistance” in President’s FY 2012 Budget Request for the U.S. 

Department of Education, P-29. 5 The statutory language appears in an appendix to this study. 6 This study assumes throughout that “the credit” referenced in the statutory language is the AOTC. Section 25A 

also includes the lifetime learning credit but it was unchanged by ARRA.
5

AOTC, how the programs complement each other and where they are at odds; and Section V 

presents examples and graphs showing the level of tax credits and Pell Grants that a student 

could expect by type of institution and by income. The report generally reflects data from tax 

year 2009 and academic year 2009-10 and the education programs that were in place in 2009 and 

2010. Section VI describes other coordination issues to consider; and Section VII discusses 

some options for increased coordination. Section VIII presents an option for expediting the 

delivery of the credit and Section IX discusses the feasibility of adding a service requirement as 

an additional condition of AOTC eligibility. Section X concludes.

II. Higher Education Market Overview

Table 1 documents changes in postsecondary enrollment over the last decade.7 These data 

compare enrollments in the fall of 1999 to the fall of 2009. In the fall of 2009, 17.6 million 

undergraduate students were enrolled in a postsecondary institution, roughly 40 percent more 

than the number enrolled ten years earlier. Slightly more than 11 million students were enrolled 

full-time in the fall of 2009, an increase of 44 percent compared to the fall of 1999. Over 6 

million students were enrolled part-time in 2009, compared to about 5 million part-time students

in 1999. Although the number of part-time students increased substantially, due to the larger 

increase in full-time enrollments, this represents a 3.5 percent decrease in the share of students 

attending part-time. The distinction between full-time and part-time enrollment is important, 

because the amount of student aid for which a college-age person is eligible depends on 

enrollment intensity. For example, students enrolled less than half time are not eligible for the 

AOTC and students enrolled less than full time may not qualify as dependent children for 

purposes of the EITC or the dependency exemption.

The majority of both full-time and part-time students in both 1999 and in 2009 were enrolled in 

public institutions. Part-time enrollment increased between 1999 and 2009 for all school types 

except private not-for-profit 2-year schools, where enrollment contracted by 25 percent. Part-

 7 Table 1 does not include enrollments at less-than two-year institutions. The table is also limited to fall enrollments 

and may therefore understate total enrollments, particularly at two-year institutions.
6

time enrollment grew most rapidly at private for-profit institutions, increasing over 700 percent 

at 4-year schools and 62 percent at 2-year schools. Full-time enrollment also grew most rapidly 

at private for-profit schools, increasing over 400 percent at 4-year schools and over 100 percent 

at 2-year schools. Full-time enrollment increased between 1999 and 2009 for all other school 

types except private not-for-profit 2-year schools, where enrollment decreased by 50 percent.

Thousand Percent Thousand Percent

17,565 100.0 12,681 100.0 38.5

6,422 36.6 4,946 39.0 29.8

Private, for-profit 2-year 41 0.2 25 0.2 62.3

Private, for-profit 4-year 330 1.9 41 0.3 711.7

Private, not-for-profit 2-year 11 0.1 15 0.1 -25.3

Private, not-for-profit 4-year 439 2.5 416 3.3 5.6

Public 2-year 4,221 24.0 3,408 26.8 23.8

Public 4-year 1,381 7.9 1,042 8.2 32.5

11,144 63.4 7,735 61.0 44.1

Private, for-profit 2-year 345 2.0 166 1.3 107.6

Private, for-profit 4-year 871 5.0 157 1.2 454.5

Private, not-for-profit 2-year 23 0.1 47 0.4 -50.4

Private, not-for-profit 4-year 2,120 12.1 1,705 13.4 24.3

Public 2-year 2,881 16.4 1,931 15.2 49.2

Public 4-year 4,904 27.9 3,729 29.4 31.5

Total Part-Time

Total Full-Time

Source: Digest of Education Statistics: 2010, Table 202 and 2002 Table 178. National Center for 

Education Statistics, U.S. Department of Education.

Table 1

Number of Undergraduate Students by Part-Time Status and Institution Type, 

Fall 2009 and Fall 1999

Fall 2009 Enrollment Fall 1999 Enrollment Percent 

Change 

Total Students

Growth in enrollment across school types between 1999 and 2009 is reflected in changes in the 

number of institutions between these school years. Table 2 documents changes in the number of 

degree-granting institutions between the 1999-2000 academic year and the 2009-2010 academic 

year. As shown in this table the number of 4-year public and private not-for-profit schools has 

been relatively stable over the last 10 years. Compared to the 1999-2000 academic year, there 

were 9 percent more 4-year public schools and 1 percent more private not-for-profit 4-year 

schools in 2009-2010. In contrast, during this same period, the number of private not-for-profit
7

2-year schools dropped 43 percent, while the number of public 2-year schools decreased 6 

percent. The number of private for-profit schools also grew substantially during this period. In 

the 1999-2000 school year, there were 721 private for-profit schools; by the 2009-2010 academic 

year, there were nearly 1,200 private for-profit schools.

2009-2010 1999-2000

Percent 

Change

Private, for-profit 2-year 636 503 26.4

Private, for-profit 4-year 563 218 158.3

Private, not-for-profit 2-year 85 150 -43.3

Private, not-for-profit 4-year 1,539 1,531 0.5

Public 2-year 1,000 1,068 -6.4

Public 4-year 672 614 9.4

Total Number of Degree Granting Institutions, 

2009-2010 and 1999-2000 Academic Years

Note: Number of institutions includes branch campuses. 

Source: Digest of Education Statistics: 2010, Table 275. National Center for 

Education Statistics, U.S. Department of Education.

Table 2

The cost of an undergraduate education is substantial, and these costs are rapidly increasing. As 

shown in Table 3, during the 2009-2010 academic year, average published, as opposed to net 

after financial aid, tuition and required fees ranged from $2,300 at public 2-year institutions to 

$25,600 at 4-year private not-for-profit colleges and universities for full-time enrollees at degreegranting institutions. In comparison to prices ten years earlier, tuition and required fees had 

increased by 35 percent at 2-year public schools and by 20 percent at 2-year private not-forprofit institutions, adjusted for inflation. At 4-year institutions, tuition and required fees also 

increased, growing 36 percent at private not-for-profit institutions and 56 percent at public 

institutions (again, adjusted for inflation). Room and board charges increased substantially 

between the 1999-2000 and 2009-2010 academic years. Among 2-year institutions, room and 

board charges increased 9 percent at private not-for-profit institutions and 23 percent at public 

institutions (again, adjusted for inflation). Among 4-year schools, room and board charges 

increased 20 percent at private not-for-profit schools and 32 percent at public schools (again, 

adjusted for inflation). 
8

2009-2010 1999-2000

Percent 

Change 2009-2010 1999-2000

Percent 

Change

Private, for-profit 2-year 15,100 - - 10,900 - -

Private, for-profit 4-year 15,200 - - 10,100 - -

Private, not-for-profit 2-year 12,700 10,600 19.8 8,100 7,400 9.5

Private, not-for-profit 4-year 25,600 18,800 36.2 9,500 7,900 20.3

Public 2-year 2,300 1,700 35.3 5,400 4,400 22.7

Public 4-year 6,700 4,300 55.8 8,300 6,300 31.7

Note: All dollar amounts in constant 2009 dollars and rounded to the nearest $100. Values for public institutions are charges for instate students. Data not available for private, for-profit institutions in the 1999-2000 academic year.

Source: Digest of Education Statistics: 2010, Table 345. National Center for Education Statistics, U.S. Department of Education.

Table 3

Institution Type

Average Undergraduate Tuition and Room and Board,

2009-2010 and 1999-2000 Academic Years

Tuition and Required Fees Room and Board

Table 4 shows graduation rates among full-time students who first enrolled in the fall of 2001.8

 

The top panel of Table 4 shows graduation rates among those enrolled in 4-year institutions, and 

the bottom panel shows graduation rates for those enrolled in 2-year institutions. The majority of 

students enrolling as full-time students in public or private not-for-profit 4-year institutions 

completed their degree within six years. Among 4-year schools, students attending private notfor-profit institutions graduated at higher rates (64 percent) than students attending public 

institutions (55 percent). In contrast, only one in four students beginning at a private for-profit 4-

year institution completed the degree within six years. Women who enrolled at 4-year schools 

were more likely than men to complete their bachelor’s degree within six years at both public 

and private not-for-profit institutions although women were less likely to complete their degree 

at for-profit institutions. The majority of first-time college students who enrolled in a private 

not-for-profit or private for-profit 2-year institution in 2001 graduated with a certificate or 

associate’s degree within 150 percent of normal time. Less than one in four first-time students 

who enrolled in a public 2-year school in 2001 completed their program within this time frame. 

 8 Graduation rates are for students who are first-time, fall enrollees at students’ initial institution.
9

All Students Male Female

Private, for-profit 4-year 25 28 21

Private, not-for-profit 4-year 64 61 67

Public 4-year 55 52 58

Private, for-profit 2-year 59 59 59

Private, not-for-profit 2-year 55 57 52

Public 2-year 23 22 24

Table 4

Graduation Rates of First-time Postsecondary Students Starting as 

Full-time Degree Seeking Students in 2001, by Institution Type

Source: Digest of Education Statistics: 2009, Table 331. National Center for Education Statistics, U.S. Department 

of Education.

Percent Completing Bachelor’s Degree within 6 years after start

Percent Completing Certificate or Associate’s Degrees within 

150 percent of normal time

Table 5 shows the age distribution of students by institution type for students enrolled in the fall

of 2009. Traditional college-age students (18-24) represented the majority of enrollment in most 

categories. At not-for-profit institutions and 2-year for-profit institutions, students aged 18-24 

accounted for at least 47 percent of enrollment. By comparison, 4-year for-profit institutions 

enrolled relatively older students. In 2009, only 25 percent of all students enrolled at 4-year forprofit institutions were traditional college age. Many students in the 25-34 age range at 4-year 

institutions are likely to be graduate students or students seeking professional degrees. In 

contrast, students in this age range who attend 2-year institutions or for-profit institutions are 

likely working towards their first postsecondary degree. At 2-year public and 2-year private notfor-profit institutions, between 21 and 24 percent of students were between the ages of 25 and 

34. At private for-profit institutions, students ages 25-34 accounted for 31 percent of enrollment 

at 2-year schools and 38 percent of enrollment at 4-year schools. Private for-profit 4-year 

institutions also enrolled a relatively larger share of students aged 35-49. This pattern suggests 

that private for-profit 4-year schools serve a different segment of the education market, 

compared to public and private not-for-profit institutions, or private for-profit 2-year schools.
10

Under 24 25-34 35-49 50 and older

Private, for-profit 2-year 47 31 17 4

Private, for-profit 4-year 25 38 29 7

Private, not-for-profit 2-year 56 24 16 4

Private, not-for-profit 4-year 60 23 12 4

Public 2-year 60 21 14 5

Public 4-year 69 20 8 2

Share of Total Fall Enrollment by Student Age and Institution Type, 2009

Notes: Enrollment at degree granting institutions, including both part-time and full-time 

students. For-profit enrollment calculated by author. Numbers do not add to 100 percent 

because age is unknown for some students.

Source: Digest of Education Statistics: 2010, Table 201. National Center for Education 

Statistics, U.S. Department of Education.

Table 5

III. Overview of Federal Support for Higher Education

The American Opportunity Tax Credit and the Pell Grant are the largest federal provisions that 

support higher education but they are not the only provisions. In FY2010, over $145 billion of 

financial aid was available to undergraduate students in the form of federal grants, loans, and the 

Federal Work-Study Program (Federally subsidized jobs for students). In the same fiscal year, 

almost $29 billion in tax expenditures was also available to students and their families (see Table 

6 below). In addition, states, colleges, universities, not-for-profit organizations, and the private 

sector also offer students financial assistance. During the 2009-2010 academic year, grant aid 

from these sources amounted to $41 billion.9 Because interactions among the AOTC, Pell 

Grants, and the wider array of available programs affect the amount of aid available as a whole, 

this section briefly reviews all Federal support available to students pursuing higher education. 

The wide array of programs is an attempt to address the needs of all students, for example those 

students who can only afford to attend part-time as well as those who attend full time, the young 

who are beginning their postsecondary educations, and older workers who need retraining. 

Some programs are designed to help parents save for future education expenses. Other programs

 9 See College Board (2010) Figure 2A. 
11

support students currently in school, and still others alleviate the burden of repaying loans after 

schooling is complete. 

A. Higher Education Tax Expenditures

Tax expenditures may take the form of a tax credit (refundable or non-refundable), a deduction, 

an exclusion, or a deferral. Generally, if an expense would qualify under more than one 

provision, current law allows only one tax benefit for the particular educational expense. 

Table 6 shows estimates of the FY 2010 income tax expenditures for higher education.10 

Descriptions for each of the tax expenditures are provided below. At $15 billion, the tax 

expenditure estimate for the AOTC accounts for over half of all the higher education tax 

expenditures but there are other significant tax expenditures for higher education. The tax 

expenditure for the Lifetime Learning Credit, a credit targeted at older and less than half-time 

students, is $3.5 billion per year. The expenditure for the parental personal exemption for 

students age 19 and over is $3 billion annually and the annual tax expenditure for the exclusion 

of scholarship and fellowship income is $2.8 billion.

 10 Table 6 only shows the income tax expenditure for each provision. Provisions that exclude income may also 

affect a student or family’s payroll tax liability. Tax expenditures are also calculated on a provision-by-provision 

basis. Although the total education related income tax expenditures amount to $29 billion per year, because of 

interaction affects repealing all of the tax expenditures listed in Table 6 would not be expected to raise $29 billion 

annually in revenue.
12

($ millions)

American Opportunity Tax Credit $15,110

Lifetime Learning Tax Credit $3,490

Parental personal exemption for students age 19 and over $2,960

Exclusion of scholarship and fellowship income $2,760

Deductibility of student-loan interest $1,480

State prepaid tuition plans1 $1,390

Deduction for higher education expenses $760

Exclusion of employer provided educational assistance $680

Exclusion of interest on savings bonds $20

Total $28,650

Estimates of Higher Education Tax Expenditures for FY2010

Table 6

Source: Table 17-2, Fiscal Year 2012 Analytical Perspectives, Budget of the U.S. 

Government.

1 Includes tax expenditure for excluded earnings on all tax preferred education savings 

plans.

Tax Credits. In 1997, the Hope Scholarship Credit and the Lifetime Learning Credit (LLC) were 

created to help families with higher education expenses. In 2009, ARRA replaced the Hope 

Credit with the AOTC for tax years 2009 and 2010. TRUIRJCA extended the AOTC to tax 

years 2011 and 2012 and through 2017 as part of the ATRA. Prior to ARRA, a taxpayer could 

claim a Hope Credit for 100 percent of the first $1,200 and 50 percent of the next $1,200 in 

qualified tuition and related expenses (for a maximum credit of $1,800 per student) for the first 

two years of college for a student enrolled at least half-time. Qualified tuition and related 

expenses for the Hope credit was limited to tuition and fees required for enrollment or attendance 

of the taxpayer, the taxpayer’s spouse or the taxpayer’s claimed dependent. With the AOTC, a 

taxpayer can claim 100 percent of the first $2,000 and 25 percent of the next $2,000 in qualified 

tuition and related expenses (for a maximum credit of $2,500) for the first 4 years of college for 

a student enrolled at least half-time. Forty percent of the otherwise available AOTC is 

refundable (for a maximum refundable credit of $1,000). Qualified expenses under the AOTC 

were expanded to include required course materials, such as books.
13

Alternatively, a taxpayer may claim a nonrefundable LLC for 20 percent of up to $10,000 in 

qualified tuition and related expenses (for a maximum credit of $2,000) per taxpayer, 

irrespective of the number of students in the taxpayer’s family, for any postsecondary education. 

Qualified expenses for the LLC only include tuition and fees required for enrollment or 

attendance, not course materials. In 2012, the LLC phased out for those earning between 

$52,000 and $62,000 of modified adjusted gross income (AGI) ($104,000 and $124,000 if 

married filing jointly) and the AOTC phased out between $80,000 and $90,000 of modified AGI 

($160,000 and $180,000 if married filing jointly). Only one credit may be claimed by or on 

behalf of any eligible student. 

Table 7 shows the distribution of returns that claimed an AOTC in 2009. In total, 9 million 

returns received $15.8 billion of AOTC in 2009 with an average AOTC of $1,760. Most returns 

with an AOTC had less than $150,000 of AGI. Upper middle-income returns tended to have 

slightly larger average credits than lower income returns because higher income families tend to 

have more eligible expenses. This is because, on average, they attend more expensive schools 

and are less likely to receive grant aid. 

Thousands Percent Thousands Percent

Percent 

with Outlay $ Millions Percent Average $ Millions Percent Average

Less than or Equal to $0 89 1.0 82 1.7 92.6 $81 0.5 $913 $73 1.9 $888

$0 to $10,000 990 11.0 977 20.1 98.7 $785 5.0 $793 $768 19.7 $786

$10,000 to $20,000 1,428 15.9 1,319 27.1 92.3 $1,517 9.6 $1,062 $1,031 26.5 $782

$20,000 to $30,000 1,150 12.8 979 20.2 85.1 $1,742 11.0 $1,515 $749 19.3 $765

$30,000 to $50,000 1,608 17.9 999 20.6 62.1 $3,018 19.1 $1,877 $821 21.1 $822

$50,000 to $75,000 1,281 14.3 396 8.1 30.9 $2,806 17.8 $2,191 $346 8.9 $874

$75,000 to $100,000 995 11.1 89 1.8 9.0 $2,355 14.9 $2,367 $87 2.2 $976

$100,000 to $150,000 1,115 12.4 17 0.3 1.5 $2,861 18.1 $2,565 $15 0.4 $909

$150,000 to $200,000 324 3.6 1 0.0 0.3 $637 4.0 $1,968 $0 0.0 $0

Over $200,000 0 0.0 0 0.0 0 $0 0.0 $0 $0 0.0 $0

Total 8,980 100.0 4,859 100.0 54.1 $15,802 100.0 $1,760 $3,890 100.0 $801

Notes: Excludes US Territories.

 Taxpayers with negative AGI are not shown, but are included in the totals.

Source: Statistics of Income (IRS), Individual Income Tax Returns for Tax Year 2009

Table 7

American Opportunity Tax Credit - US Totals - Tax Year 2009

Adjusted Gross Income

Returns with AOTC Dollars of AOTC

Total Returns with Outlay Total Outlay

As also shown in Table 7, 4.9 million returns received AOTC outlays in 2009 (outlays are the 

portions of the AOTC that are refunded). For these returns, the value of the AOTC that they 
14

received exceeded their individual income tax liability. This is the same population that is likely 

to be eligible for a Pell Grant. 

The AOTC is partially but not fully refundable. Although the maximum AOTC is $2,500, if a 

taxpayer does not have $1,500 of tax liability then he or she cannot receive the maximum credit 

even if he or she would otherwise qualify because only $1,000 may be received as a refundable 

credit. A taxpayer with no individual income tax liability may receive a payment (referred to as 

an outlay or refundable credit) of up to a $1,000. Taxpayers with individual income tax liability 

greater than zero but less than $1,500 may receive a $1,000 outlay (refundable credit) plus a 

credit equal to their tax liability (if they are otherwise eligible). For example, if a taxpayer had 

$400 of tax liability before credits and otherwise qualified for a $2,500 AOTC, he or she would 

receive a $1,400 AOTC equal to a $1,000 refundable credit plus a $400 credit that would 

completely offset their individual income tax liability. Of the $15.8 billion dollars of AOTC in 

2009, only $3.9 billion (25 percent) was an outlay. The average outlay was $801 in 2009.

Low-income working families may also be eligible for a (fully refundable) earned income tax 

credit (EITC). The value of the credit varies with the number of qualifying children, marital 

status, and with family income. In general, dependent children over the age of 18 do not qualify

the taxpayer for this benefit. However, in the case of full-time students, the age limit is extended 

through 23. A married couple with one child would be eligible for an EITC of up to $3,169 in 

2012, which would phase out completely at $42,130 of AGI.

Deductions. For parents supporting college students, there is also an extension of the benefit 

provided by the dependency exemption deduction for full-time students aged 19 through 23. 

Dependent children over the age of 18 do not qualify as children for the dependency exemption 

unless they remain full-time students (up to age 23). In 2012, the personal exemption amount 

was $3,800.

Taxpayers may also be eligible for a deduction above-the-line (i.e., without itemization) for up to 

$2,500 of interest per year on any qualified education loan, subject to a modified AGI phase-out 
15

between $60,000 and $75,000 ($120,000 and $150,000 if married filing jointly) in 2012.

11 The 

income tax expenditure for the deductibility of student-loan interest was $1.5 billion in FY2010.

Through tax year 2013, a taxpayer may also claim an above-the-line deduction for qualified 

tuition and related expenses (commonly referred to as the tuition deduction). The maximum 

amount of the deduction is $4,000 for taxpayers with AGI not exceeding $65,000 ($130,000 if 

married filing jointly), or $2,000 for taxpayers with AGI greater than $65,000 and not exceeding 

$80,000 (greater than $130,000 and not exceeding $160,000 if married filing jointly). The 

income tax expenditure for the deduction of higher education expenses was $800 million in 

FY2010.

In addition, deductions may be allowed for certain work-related education expenses. An 

employee who itemizes may deduct work-related education expenses as one of a class of 

miscellaneous itemized deductions subject to a floor of two percent of AGI. 

An employee for whom the employer pays education expenses that would be deductible by the 

employee as work-related expenses if the employee had paid the expenses may exclude the 

amounts from gross income as a working condition fringe benefit. 

Exclusions from Income. In addition to any available credits or deductions, a student who 

receives a qualified scholarship to a degree-granting program (including certain Federal medical 

training programs) may exclude from gross income amounts used to pay qualified tuition and 

related expenses, including fees, books, supplies, and required equipment. However, students 

must include in gross income the portion of scholarship awards and grants (including Pell 

Grants) that are used to pay living expenses. Under another provision, enacted in 1976 and 

substantially expanded in 1997 and 2007, a student may also exclude from gross income the 

amount of a loan that is forgiven if the student works for a required period of time in certain 

professions or locations. Additionally, there is an unlimited exclusion from the gift and 

 

11 ATRA made permanent the higher student loan interest deduction phase-out limits for joint filers (first enacted 

under EGTRRA). Modified AGI for the purpose of calculating the student loan interest deduction is AGI as 

calculated on a taxpayer’s federal income tax return before subtracting any deduction for student loan interest.
16

generation-skipping transfer tax for tuition paid directly to a school on behalf of a student, 

resulting in an incentive to make gifts of college tuition for those donors (whether related or not 

to the student) who are living when the tuition payment is due.

There are also incentives for individuals to continue their education while employed. Since 

1979, an employee has been allowed to exclude employer-provided expenses (up to $5,250 since 

1986) that are part of an Educational Assistance Program (EAP).12 Under an EAP, there is no 

requirement that the education be work-related. Employers may also exclude (without limit) 

from gross income employer reimbursements for work-related education spending made under a

qualified accountable plan. To qualify as an accountable plan, the expenses must be workrelated, the employee must adequately account to his or her employer for his or her expenses 

within a reasonable period of time, and the employee must return any reimbursement or 

allowance in excess of the expenses accounted for within a reasonable period of time. The tax 

expenditure for the exclusion of employer provided educational assistance was $700 million in 

FY2010.

Certain colleges and universities offer tuition-reduction programs to their employees (which can

include the employee’s spouse or dependent child). Tuition benefits under such programs may 

be excluded from gross income. Also, certain graduate students employed in teaching or 

research may exclude tuition reductions from gross income. As noted above, if an employer 

pays the educational expenses of an employee directly, the employee may exclude the payments 

from gross income as a working condition fringe benefit if the employee could have deducted the 

expenses as a work related educational expense had the employee paid the expense.

Savings Related Deferrals and Exclusions. Individuals may benefit from the deferral of tax by 

saving for retirement in an Individual Retirement Account (IRA). Withdrawals from IRAs made 

before the taxpayer is 591⁄2 are generally subject to a 10 percent additional income tax (in 

addition to the ordinary income tax on taxable distributions). Since 1997, an IRA distribution for 

qualified higher education expenses has been permitted, with the 10 percent additional income 

 12 The employer provided education provision has been extended repeatedly, most recently by ATRA which made it 

permanent. 
17

tax waived, although the ordinary income tax on the taxable portion of the distribution is still 

due. The exemption from the additional income tax covers both Traditional and Roth IRAs, 

allowing for tax-deferred saving effectively without income limits on contributors, encompassing 

family members including grandchildren as beneficiaries, and extending beyond tuition and fees 

to room and board (for students attending college at least half-time).

In addition, individuals at all income levels may contribute to Qualified Tuition Programs, or

section 529 plans. These plans can take the form of a 529 savings account or a prepaid tuition 

plan. In either case, contributions accumulate tax free and are not taxed upon distribution if used 

for qualified education expenses. The plans are run by the States, with the exception of one plan 

that provides a prepaid tuition plan for a consortium of private postsecondary institutions. Some 

states also permit contributors to deduct a limited amount of contributions for state income tax 

purposes. The tax expenditure for the exclusion of earnings accruing in all prepaid tuition and 

savings plans was $1.4 billion in FY2010.

In 1997, an additional tax preferred savings vehicle was created in the form of an Education IRA. 

Subject to an AGI phase-out, contributors were allowed to contribute up to $500 per beneficiary 

per year to an Education IRA. The contribution limit was increased in 2001 to $2,000 for each 

beneficiary and the accounts were renamed Coverdell Education Savings Accounts (ESAs). 

Like 529s, contributions to Coverdell ESAs accumulate tax free and are not taxed upon 

distribution if used for qualified expenses. 

Finally, subject to income limitations, an exclusion from income of interest on qualified United 

States Savings Bonds has been available since 1988, provided that the proceeds are used to pay 

for qualified higher education expenses. The tax expenditure for the exclusion of interest on 

savings bonds was $20 million in FY2010.
18

B. Direct Federal Financial Aid for College Students

The principal Federal student financial assistance programs are authorized under Title IV of the 

Higher Education Act of 1965, as amended, and provide grant, loan and work-study assistance to 

students and their families.

Table 8 shows the amount of Federal aid available by program. The major programs are 

described briefly below. Pell Grants and Federal loans are the largest programs.

Amount Recipients Average

($ millions) (thousands) ($)

Pell Grants $36,515 8,873 $4,115

Supplemental Educational Opportunity Grants $959 1,339 $716

Federal Work-Study $1,171 713 $1,642

Leveraging Educational Assistance Partnerships $162 162 $1,000

Academic Competitiveness Grants $548 786 $697

SMART Grants $384 150 $2,500

Federal Family Education Loans1,2 $19,618 5,220 $3,758

Federal Direct Loans2 $84,704 16,646 $5,089

Perkins Loans $971 493 $1,968

TEACH Grants $109 37 $2,966

Iraq and Afghanistan Service Grants * * $4,816

Subtotal Student Loans $105,400

Total3 $145,138

Source: Fiscal Year 2013 Budget Department of Education

1

 This program ended June 30,2010, as stipulated in the Student Aid and Fiscal Responsibility Act. 

All new loans as of July 1, 2010 are originated in the Federal Direct Loan Program.

2

 Loan amounts reflect the face value of the loan, not the subsidy level.

3

 Totals may not sum due to rounding.

* Less than $1 million or 1,000 recipients.

Table 8

Federal Postsecondary Student Aid FY2010 

Need-Based Grants. Pell Grants are need-based grants available to low-income undergraduate 

students.13 They are the largest source of grant aid and are available for use at more than 5,400 

 13 Certain post-baccalaureate students in teacher certification programs may also be eligible.
19

institutions with more than 1 in 3 undergraduates receiving a Pell award during the 2010-2011 

award year.

14 Recipients must be undergraduates and cannot have received a bachelor’s degree 

previously (with the exception of certain teacher certificate programs), and must be enrolled with 

the purpose of obtaining a degree or certificate at an eligible institution. Students must have a 

high school diploma (or its equivalent). Less than full-time students are eligible for pro rata 

awards based on their enrollment status.

As shown in Table 8, in FY2010, the Pell Grant program offered $36.5 billion in aid to more 

than 8.8 million undergraduate students for an average grant of $4,115.

15 In contrast, in FY2008

the Pell program offered half as much aid, $18.3 billion to 6.2 million students for an average 

grant of $2,971.16 

There are four major causes behind the growth in Pell Grant costs:

1. Demographic changes and increases in the number of eligible students (40 percent of 

increase). The largest single driver of Pell Grant cost increases has been the increase in 

applicants and their relative financial need. Because of the recent recession, more 

individuals chose to pursue or return to higher education and a higher percentage of 

students were from low-income families. The largest growth in applicants has been 

among those in the lowest income categories who receive the largest Pell Grants. 

2. Increases to the maximum award (22 percent of increase). Between 2008 and 2009, the 

discretionary maximum Pell Grant grew by $619, from $4,241 to $4,860. Additional 

(mandatory) funding increased the maximum Pell by another $690 to $5,550.

 14 See Department of Education, “Description of Federal Pell Grant Program,” 

http://www2.ed.gov/programs/fpg/index.html, “Postsecondary Institutions and Price of Attendance in 2011-2012, 

Degrees and Other Awards Conferred: 2010-2011, and 12-Month Enrollment: 2010-2011 First Look Provisional 

Data,” http://nces.ed.gov/pubs2012/2012289rev.pdf, and “Title IV Program Volume Reports” 

http://studentaid.ed.gov/about/data-center/student/title-iv. 15 U.S. Department of Education (2011) “FY 2012 Department of Education Justifications of Appropriation 

Estimates to the Congress: Student Financial Assistance” in President’s FY 2012 Budget Request for the U.S. 

Department of Education, P-24. 16 Ibid.
20

3. Second Pell/Year-round Pell (21 percent of the increase). The Higher Education 

Opportunity Act of 2008 created “year-round Pell Grants,” which allowed students who 

complete more than two semesters of study in one school year to receive an additional 

(i.e., second) Pell Grant for a summer semester. This benefit was originally projected to 

cost about $300 million a year but take-up was much higher than anticipated. 

Approximately 10 percent of Pell recipients benefitted in 2010 creating costs more than 

ten times higher than the Congressional Budget Office’s original estimate.17

4. Need analysis changes (14 percent of the increase). Legislation in 2007 and 2008 

expanded the number of students who qualify for the maximum award, and allowed some 

students to qualify for larger awards. These need analysis changes were generally 

targeted at the neediest students.18

Table 9 shows the distribution of Pell Grant recipients and awards by income for the 2009-2010 

academic year. Pell Grants are generally awarded to dependent students whose parents have 

income less than $60,000 per year and to independent students whose income is less than 

$30,000 per year.19 Grant amounts are calculated using a formula that compares costs of 

attendance to the expected contribution of the student and his or her family to the student’s 

education (the Expected Family Contribution, or EFC) with any shortfall made up by a Pell 

Grant, subject to the maximum award amount for that year. The cost of attendance includes 

tuition and fees, books, and living expenses. The EFC is calculated by the Department of 

Education using a statutory formula that considers the financial resources and household 

 17 This benefit was eliminated by Congress after 2011.

18 Over the past several years, Congress and the Administration have enacted a series of changes to student aid 

programs to provide sufficient budget authority to fund the maximum award. The 2011 Appropriation bill 

eliminated the availability of two full Pell awards in an academic year. The Budget Control Act eliminated graduate 

students’ eligibility for subsidized loans and appropriated the savings to the Pell Grant program. In the Consolidated 

Appropriations Act of 2012, additional changes were made to the Federal student aid programs to ensure that there 

were sufficient resources to pay for the $5,550 maximum Pell Grant. The changes included raising the minimum 

award level to 10 percent, eliminating the interest subsidy on subsidized Stafford loans during the grace period for 

academic years 2012-2013 and 2013-2014, decreasing the maximum eligibility for Pell Grants from 18 to 12 

semesters, reducing the income threshold for an automatic maximum grant, and tightening eligibility rules to 

exclude new students without a high school diploma or the equivalent. The changes became effective July 1, 2012.

19 The income limits described here assume a very simple case where families have few other resources and very 

limited assets. The actual process for determining eligibility is complex and various financial factors will affect 

these cut-offs. 
21

circumstances of the student and the student’s family (including, primarily, the student’s income 

and financial assets, the family’s income and financial assets, family size, and the number of 

additional family members attending postsecondary education). Part-time students and students 

attending less than a full academic year receive prorated grants. Notably, although private forprofit institutions account for 9 percent of enrollments, they accounted for over 25 percent of 

total Pell Grant recipients in 2009-2010.

Thousands Percent

Total 

$ Millions Percent Average

Less than or Equal to $0 800 9.9 $3,181 10.6 $3,975

$0 to $10,000 1,956 24.2 $7,976 26.6 $4,078

$10,000 to $20,000 2,006 24.8 $7,512 25.0 $3,744

$20,000 to $30,000 1,361 16.8 $5,653 18.8 $4,154

$30,000 to $50,000 1,519 18.8 $4,762 15.9 $3,136

$50,000 to $75,000 432 5.3 $872 2.9 $2,019

$75,000 to $100,000 19 0.2 $33 0.1 $1,740

$100,000 to $150,000 1 0.0 $3 0.0 $3,361

$150,000 to $200,000 0 0.0 $0 0.0

Over $200,000 0 0.0 $0 0.0

Total 8,094 100.0 $29,992 100.0 $3,706

1

 Income is measured at 2008 levels. Total Income equals AGI plus untaxed income and benefits.

Source: Unpublished tabulations from the U.S. Department of Education.

Table 9

Distribution of Pell Grant Recipients and Awards by Income for Academic Year 2009-2010

Total Income1

Pell Grant Recipients Pell Grant Awards

In addition to Pell Grants, Federal Supplemental Educational Opportunity Grants (FSEOGs) are 

available to undergraduates with exceptional financial need. Like Federal Work-Study and 

Perkins Loan, FSEOG is a campus-based program. Institutions select FSEOG recipients and set 

their grant levels, but Federal guidelines stipulate that students with “exceptional need” and who 

are Pell Grant recipients have priority in the selection process. Thus, the financial aid office at a 

student’s school has some discretion over who receives an FSEOG and how much they receive. 

Schools that choose to participate in the FSEOG program must contribute one dollar for every 

three dollars they receive from the Federal government. Approximately 3,800 schools 

participated in the FSEOG program in FY2010. The maximum FSEOG is $4,000 a year. 
22

Approximately 1.3 million students received $959 million in FSEOG awards in FY2010 for an 

average award of $716.

Other Grant Programs. The Academic Competitiveness Grant (ACG) was made available for 

the first time for the 2006-2007 academic year. It provided up to $750 for the first year of 

undergraduate study to students who had completed a rigorous secondary school program and up 

to $1,300 for the second year of undergraduate study to students who maintained at least a 

cumulative 3.0 grade point average (GPA) on a 4.0 scale as of the end of the first year of 

undergraduate study. The ACG award was restricted to Pell recipients and was in addition to the 

student's Pell Grant award. Approximately 786,000 students received $548 million in ACG 

grants in FY2010 for an average award of almost $700.

20 

The National Science & Mathematics Access to Retain Talent Grant (National SMART Grant)

provided up to $4,000 per academic year during the third and fourth years of undergraduate 

study (or fifth year of a five-year program) to at least half-time students who were eligible for the 

Federal Pell Grant and who were majoring in physical, life, or computer sciences, mathematics, 

technology, engineering or a critical foreign language; or non-major single liberal arts programs. 

The student was also required to maintain a cumulative grade point average (GPA) of at least 3.0 

in course work required for the major. The National SMART Grant award was in addition to the 

student's Pell Grant award. Approximately 150,000 students received $384 million in SMART 

grants in FY2010 for an average award of $2,500.

21

The TEACH Grant Program was created in the College Cost Reduction and Access Act of 2007. 

It provides up to $4,000 per year to students who intend to teach in a public or private 

elementary or secondary school that serves students from low-income families. (Students who 

fail to complete the teaching requirement must repay the grant with interest in the form of an 

unsubsidized Stafford loan.)

 

 20 Funding authority for ACG program expired on June 30, 2011. 21Authority to make National SMART grants ended June 30, 2011.
23

Loans.

22 A Federal Perkins Loan is a low-interest loan for both undergraduate and graduate 

students with exceptional financial need. Eligible students may borrow up to $5,500 for each 

year of undergraduate study (maximum of $27,500 for undergraduate study) and up to $8,000 

per year for graduate study (maximum of $60,000 for both undergraduate and graduate study). 

Students do not pay interest on the loan while in school or during nine month grace period after 

leaving school. Approximately 500,000 students received almost $971 million in Perkins loans 

in FY2010 with an average loan of $1,968.

23 

A Direct Subsidized Stafford Loan24 is a low interest rate loan available to students with 

financial need. The maximum amount a student may borrow in the first undergraduate year is 

$3,500 but the yearly maximum increases with succeeding years of schooling. Students whose 

loans originated prior to July 1, 2012 do not pay interest on the loan while in school or during six 

month grace period after leaving school. 

A Direct Unsubsidized Stafford Loan is a low interest rate loan available to all students 

independent of need. The maximum amount a student may borrow is $5,500 (including the 

amount of any subsidized loan) in the first undergraduate year but the yearly maximum increases 

with succeeding years of schooling. Interest on the loan accrues from the time of disbursement 

but payment may be deferred while the student is in school and during the six month grace 

period after leaving school.

C. State and Institutional Aid

As shown in Table 10, 64 percent of full-time, full-year students receive grant aid, 33 percent 

receive Federal grant aid and 53 percent receive state, institutional and/or private grants (some 

 22 The loan programs described here are those available in 2009 and 2010. The rules and limits for currently 

available loans may differ from those described in this report.

23 Statutory authority to operate the Perkins loan program will expire in 2014. 24 Before July 1, 2010, Stafford, PLUS, and Consolidation Loans were also made by private lenders under the 

Federal Family Education Loan (FFEL) Program. As a result of recent legislation, no further loans are being made 

under the FFEL Program beginning July 1, 2010. All new Stafford, PLUS, and Consolidation Loans will come 

directly from the Department under the Direct Loan Program.
24

students receive both Federal and state grant aid). Only 36 percent of full-time, full-year 

students paid the published tuition and fees (or “sticker price”) for their schooling. 

As also shown in Table 10, students receive substantial amounts of grant aid. For example, 

average published tuition and fees (excluding room and board) at a 4-year public school was 

$6,191 in 2007-2008 but the average non-Federal grant award (including awards for room and 

board) for a student receiving an award was $5,170. There are two potential interactions of 

federal and non-federal aid to note. First, additional aid by the Federal government may be 

offset or redirected at the institutional level. Because many institutions try to meet the financial 

need of their admitted students, if a student’s Federal grant aid increases by $100, the institution 

may decrease that student’s institutional grant aid by $100 or some portion of $100 and redirect 

the money toward other uses – such as merit aid, lower tuition, or enhanced facilities. Second, 

because institutional aid is significant it may decrease the amount a student may be able to claim 

for an AOTC. 

Total Federal Other Total Federal Other Total Federal Other

All Institutions 79.5 63.0 62.9 64.4 33.0 52.8 53.3 49.6 20.1 10.3

Private, not-for-profit 89.1 70.0 81.8 80.6 28.3 76.0 64.9 60.9 29.1 23.7

Public 4-year 76.7 57.5 62.1 58.9 26.1 53.1 52.7 48.6 17.1 8.4

Public 2-year 65.4 49.2 46.6 53.9 35.1 40.4 24.8 21.5 7.8

Private, for-profit 96.9 93.6 60.1 72.3 62.2 25.4 92.0 88.7 44.0 1.8

All Institutions $12,740 $8,070 $8,020 $7,110 $3,670 $6,390 $9,480 $7,050 $7,780 $2,160

Private, not-for-profit $20,740 $9,660 $14,310 $12,070 $4,060 $11,300 $12,160 $8,220 $9,910 $1,920

Public 4-year $11,470 $8,220 $6,560 $6,340 $3,700 $5,170 $8,880 $7,080 $7,220 $2,310

Public 2-year $5,650 $5,130 $2,520 $3,660 $3,270 $1,850 $5,450 $4,600 $4,690 $2,790

Private, for-profit $13,120 $9,270 $6,700 $3,990 $3,280 $3,300 $10,260 $7,110 $7,140 $3,700

Institution Type

Note: Aid averages are for those students who received the specified type of aid. Full-time, full-year students are defined as enrolled full-time for 9 

or more months from July 1 through June 30.

Source: U.S. Department of Education, National Center for Education Statistics, 2007-08 National Postsecondary Student Aid Studies, Tables 343 

and 344.

Table 10

Federal 

Work 

Study

Any Aid Grants Loans

Percent of Full-Time, Full-Year Undergraduate Students Receiving Aid and Average Amount Received 2007-2008 

by Source and Institution Type
25

IV. Comparing the American Opportunity Tax Credit and Pell Grant

Pell Grants and the AOTC make college more affordable for undergraduate students and their 

families. They target aid to needy families who are burdened by the high (and rising) cost of a 

postsecondary education. The Pell Grant is targeted to the neediest families; over half of Pell 

Grants are received by families with less than $20,000 of income. The AOTC provides tax relief 

to middle-income families as well as refundable credits for low-income families. 

The AOTC is calculated as 100 percent of the first $2,000 and 25 percent of the next $2,000 in 

expenses for qualified tuition, fees and course materials (for a maximum credit of $2,500) for the 

first 4 years of college for a student enrolled at least half-time. The Pell Grant is calculated as 

the difference between a student’s Expected Family Contribution (EFC) and the cost of 

attendance including room and board up to a maximum grant of $5,550 in 2012. The EFC is 

calculated as a function of parental income, student income, and other characteristics affecting 

available resources. Pell Grants are taxable to the extent that they are used to pay living 

expenses,

25 and like all other scholarship income, are considered earned income to the student. 

Only amounts used to pay tuition and other eligible expenses such as required fees and books are 

excludable from gross income. 

Higher education institutions are involved in the administration of Pell Grants and, to a limited 

extent, the verification of student eligibility for the AOTC. Students apply for and are awarded a 

grant through the Free Application for Federal Student Aid. Once a grant amount is determined 

by the EFC, the student can use the grant at any institution. However, the Pell Grant is not 

disbursed directly to the student, but rather to the school. The schools apply the Pell Grant

received by a student to his or her eligible school expenses and disburse remaining funds (if any) 

to the student to pay other eligible expenses directly. As discussed below, Pell Grants have a 

more expansive list of eligible expenses than the AOTC. 

 25 Stipends to recipients for participants in the National Health Service Corps Scholarship Program and the Armed 

Forces Health Professions Scholarship Program are excluded from income.
26

All higher education institutions eligible to participate in the Department of Education’s student 

aid programs are required to file an information return, Form 1098-T, with the IRS for all

enrolled students (with a few exceptions).

26 A copy of the 1098-T return is also sent to the 

student. As shown in Figure 1, the 1098-T records either payments received for tuition and 

related expenses required for enrollment (Box 1) or amounts billed for tuition and related 

expenses (Box 2). It is up to each school whether to fill in Box 1 or Box 2. The amounts 

recorded in either box only include tuition and fees required for enrollment and include 

scholarships and grants administered by the institution for the student. The scholarships and 

grants administered by the school are recorded in Box 5. Such amounts include all Federal and 

institutional grants but exclude private grants that are not administered by the school. The 1098-

T also includes a check-box to indicate that the student is enrolled at least half-time (Box 8) and 

a check-box to indicate that the student is enrolled as a graduate student (Box 9). 

Figure 1

 26 There are a few filing exceptions for the 1098-T. Schools do not have to file a 1098-T for: courses for which no 

academic credit is offered, even if the student is otherwise enrolled in a degree program; non-resident alien students, 

unless requested by the student; students whose qualified tuition and related expenses are entirely waived or paid 

entirely with scholarships; and students for whose qualified tuition and related expenses are covered by a formal 

billing arrangement where the institution bills only the student’s employer or a government entity and does not 

maintain a separate financial account for the student. 
27

Thus the 1098-T provides third-party verification that the student is enrolled at an eligible 

institution and indicates whether the student is enrolled at least half time, and whether the student 

is a graduate or undergraduate student. Only students who attend an eligible institution at least 

half-time and who pay tuition and related expenses out-of-pocket are eligible for an AOTC. 

Unfortunately, as discussed below (Section VI), the expense and grant information provided on 

the Form 1098-T is not sufficient to verify that a student’s expenses are eligible for the AOTC. 

This omission makes it more difficult for the student (or the student’s family) to calculate 

expenses eligible for the AOTC and more difficult for the IRS to verify compliance.

The following describes other similarities and differences between the Pell Grant Program and 

the AOTC.

A. Similarities

Undergraduate students only: Both the Pell Grant and the AOTC are generally limited to 

undergraduate students.27 

Part-time students: Both Pell Grants and the AOTC are available to less than full-time students. 

Pell Grants are available to students at any level of participation as long as they have not 

completed their first bachelor’s degree. Grants are prorated for part-time students. The AOTC is 

available to students attending half-time or more. 

Income limitations: Neither Pell Grants nor the AOTC are available to very high income 

families. Pell Grants are generally restricted to families with less than $60,000 of income. The 

AOTC is restricted to taxpayers with less than $90,000 of modified AGI ($180,000 if married 

filing jointly).

 27 With the exception noted above that in some cases, students who are enrolled in teacher training programs after 

completing a bachelor’s degree may still be eligible for a Pell Grant. Also, graduate students who have not 

completed four years of postsecondary programs may be eligible for the AOTC. A taxpayer may claim the AOTC 

only for four taxable years for each eligible student.
28

Low-income families: Both Pell Grants and the AOTC are available to very low-income 

families. Up to $1,000 of the AOTC is refundable, meaning that it is available to families who 

have no income tax liability. As shown in Table 9 above (Section III), over half of students with 

Pell Grants have family incomes of less than $20,000 and as shown in Table 7 above, over half 

of the taxpayers receiving an AOTC receive a credit that exceeds their income tax liability.

Eligibility based on tax data: Both Pell Grants and the AOTC use tax data to determine 

eligibility. Because Pell Grants use income data from the prior tax year, eligibility for Pell 

Grants can be determined earlier and the grant made available at the start of the school term. 

Pell Grants also use asset information for the student and parent(s) although, as discussed below

(Section VII), the additional information may not greatly affect eligibility.

B. Differences

In general Pell Grants are designed to target aid to the lowest income students; whereas, the 

AOTC offers targeted tax relief to low- and middle-income students and their families. The 

average Pell Grant ($4,115) is much larger than the average AOTC ($1,730). Pell Grants are 

paid directly to the school at the time tuition is due and may form the foundation of an aid 

package (including a family’s expected contribution) designed to cover both tuition and living 

expenses. In contrast, the AOTC offers tax relief to taxpayers who incurred out-of-pocket 

expenses for tuition, fees or course materials (including books) with the credit being claimed 

when the tax return is filed (generally months after tuition costs are incurred).

Determination of need: As discussed previously, Pell Grants are generally restricted to families 

with less than $60,000 of income and the AOTC is restricted to taxpayers with less than $90,000 

of modified AGI ($180,000 if married filing jointly). Specifically, however, the determination of 

need for Pell Grants is dependent on many factors. Under the Department of Education’s need 

analysis formulas, a family’s eligibility varies with family size, the number of students in the 

family attending college, whether the student is a dependent or not (see below), the financial 

assets of the student, and in the case of a dependent student, the income and financial assets of 

the parent(s). Under the AOTC, the computation of need is only dependent on modified AGI
29

and filing status. One option to coordinate the credits (Option 1 Section VII) would limit the 

information used to determine Pell Grant eligibility to data available on a tax return. Such a 

change would make the assessment of need between the Pell and the AOTC similar, although the 

income limitations for the AOTC would remain higher.

Definition of dependent: Unmarried students aged 19 to 23 who provide for their own support 

are not treated as their parent’s dependents under the tax code but are treated as dependents of 

their parents under the financial aid rules for the Pell Grant. Under Federal financial aid 

formulas, unmarried students younger than 24 are generally considered to be dependents, and 

their families are generally expected to contribute to their education. Pell Grant awards are 

based on this expectation and therefore may be lower or denied if the parents have significant 

income, even in the case where the parents do not actually contribute to the child’s education.28 

The age limitation is intended to limit the receipt of aid to those students who do not have access 

to parental resources.

For purposes of the dependency exemption deduction, to qualify as a dependent, a child must be 

younger than 19 years old, or younger than 24 years old and a full-time student, and who does 

not provide more than half of his or her own support. 29 For purposes of the AOTC, if a student 

is a claimed dependent of another taxpayer, only that taxpayer may claim the AOTC for that 

student. However, if another taxpayer is eligible but does not claim the student as a dependent, 

then only the student can claim the AOTC.30

 28 For the most part independent students, as defined by Federal financial aid regulations, have attained their 24th

birthday. Younger students can qualify as independent if they have children, are married, are veterans of the Armed 

Forces, are graduate students, or if their parents are deceased. These types of students are treated the same as older 

independent students for purposes of Federal financial aid. 29 The rules described here that relate to the tax codes definition of dependency are an overview. The other 

conditions that must be met for dependency are that the child must have lived with the taxpayer for more than half of 

the year (living at school qualifies), and the child must not file a joint return for the year unless it is being filed 

solely for the purpose of claiming a refund. More detailed rules may apply to specific situations (e.g. permanently 

disabled children are not subject to age tests). See IRS publication 501 for a complete list of rules at 

http://www.irs.gov/pub/irs-pdf/p501.pdf. 30 Payments of tuition, required fees and books by third parties (including parents) are deemed to be expenses paid 

by the student for the purposes of claiming the education tax credits. However, payment of these expenses by a 

parent is treated as support paid by the parent for the determination of dependency for tax purposes. 
30

Tax Liability Limitation: The level of a Pell Grant is determined by a student’s need and is only 

limited by the amount of qualifying expenses and by enrollment intensity (part-time students 

receive smaller awards). Similar to the Pell Grant, the AOTC is directed at needy families (the 

credit is phased out with income) and is limited to eligible expenses (albeit a narrower definition 

of eligible expenses, see below). The AOTC is also limited by a taxpayer’s individual income 

tax liability. For example, if a taxpayer has no individual income tax liability, then the 

maximum AOTC is only $1,000. In all cases, the refundable portion of the AOTC is limited to 

$1,000. 

Qualifying Expenses: Pell Grants can be used to pay for tuition, required fees, book, and living 

expenses such as room and board and childcare. Eligible expenses for the AOTC include only 

tuition, required fees, and course materials (including books) paid in the tax year for an academic 

period that begins in the same tax year or the first 3 months of the following tax year. 

Years of eligibility: A student may receive a Pell Grant for up to 12 semesters (or its equivalent) 

provided that the student is still pursuing his or her first bachelor’s degree. In contrast, the 

AOTC is only available for the first four years of undergraduate postsecondary education. A 

taxpayer may claim the AOTC only for four taxable years for each eligible student.

The lifetime learning credit and tuition deduction are available for students pursuing any 

postsecondary education and are available for any taxable year.

Timing of disbursements: Pell Grants are generally disbursed once per term (semester, trimester, 

or quarter) by the school. The school may apply the Pell Grant award to school costs or pay the 

student directly. In either case, the Pell Grant award is available at the time tuition is due. In 

contrast, absent changes to withholding in the case of students receiving nonrefundable credits

and in all cases for a student receiving refundable credits, an AOTC is only received after the 

taxpayer has filed his or her tax return. For expenses paid in 2012, a taxpayer would receive the 

credit in 2013 (usually by the April 15th filing deadline). For students that do not have the means 

to finance the tuition payment when it is due, the AOTC would have little value as a way to pay 

for schooling in the first year. In subsequent years, the AOTC could be saved for future tuition 
31

bills. The timing of the delivery of grant and other financial aid (including loans) generally 

serves the neediest students best.

V. Examples and Graphs of the Interaction between Pell Grants and the AOTC

A. Examples of Interaction

Tables 11 and 12 show examples of how the Pell Grant and the AOTC interact using two levels 

of taxpayer income and 3 levels of tuition, required fees and books. Table 11 shows examples 

where the student is the claimed child dependent of a head of household filer who pays the 

expenses. The examples show the tax liability for the entire family, including (potential) tax 

liability faced by the student due to receipt of the Pell Grant. Table 12 continues with Examples 

7, 8, and 9. In this table, the student is a head of household filer who has one young dependent 

child. In this case, the Pell Grant is income to the taxpayer and affects the taxpayer’s liability. In 

both tables all income, with the exception of any scholarship income, is from wages. These 

examples illustrate how the grant may be allocated to maximize the family’s tax benefits. All the 

examples in Table 11 and 12 assume that the family optimizes its total tax and grant benefits. 

Boxes 1 and 2 at the end of this subsection, give examples of how much a family might lose if 

they do not optimize. 

In order to optimize its benefits, the family must decide whether to use its grant to pay for room 

and board (or other eligible living expenses), use it to pay tuition, required fees, and books 

(AOTC eligible expenses), or a combination. If a family uses some or all of its grant to pay 

AOTC eligible expenses then that portion of the grant must be subtracted from expenses eligible 

for an AOTC. If a family uses some or all of its grant to pay room and board or other living 

expenses, then that portion of the grant must be included in the income of the student for tax 

purposes. In most of the Table 11 examples the income of the dependent student remains below 

the filing threshold for dependent filers ($5,800 for dependent filers with only earned income) 

and no tax will be owed.
32

Families optimize their tax benefits by first using scholarships (including Pell Grants) to pay 

AOTC eligible expenses in excess of $4,000. If a family still has $4,000 or more of expenses for 

tuition, required fees and books after using its scholarships to pay these expenses, then it will be 

eligible for both the maximum AOTC credit (all else equal) and it will be eligible to exclude all 

of its grants from income. If, however, a family’s tuition, required fees and books minus its 

scholarships is less than $4,000, the family needs to decide whether to use the “excess” grants to 

pay living expenses which would make them taxable or to pay AOTC eligible expenses which 

would reduce the family’s AOTC but allow the grants to be excluded from gross income. 

Generally, because the first $2,000 of eligible expenses paid by a family has a very high effective 

credit rate, most families will optimize their benefits by paying at least $2,000 of AOTC eligible 

expenses themselves even if it means using their scholarships to pay expenses that are not 

excludable from income.31 Whether a family is also better off paying the next $2,000 of AOTC 

eligible expenses themselves, even if it means using their scholarships to pay living expenses, 

depends on whether or not the marginal tax rate of the student and family is higher than the 

effective credit rate for the second $2,000 of expenses. The effective credit rate on the second 

$2,000 of eligible expenses is much lower than the first $2,000 of eligible expenses.32 For 

families where the student is a dependent, Pell Grants included in income would most likely be 

taxed at a marginal rate of 10% (and even then only to the extent the student’s income exceeds 

the standard deduction for dependents). For families where the student is the primary or 

secondary filer, calculating the relative benefit of AOTC eligible expenses in excess of $2,000 

may be more complicated if income is in the phase-out rate of the EITC (where their marginal 

tax rate is very high).

Example 1 illustrates the simplest case where the family has no EITC and sufficient tuition, 

required fees and book expenses to minimize the interaction between Pell Grants and the AOTC. 

In this example, the family has total wages of $42,000 – $40,000 attributable to the parent and 

$2,000 attributable to the student – and a Pell Grant of $1,800. The student has tuition, required 

 31 The effective credit rate for the first $2,000 of AOTC expenses ranges from 40% for families without tax liability 

(before the AOTC) to 100% for families with tax liability. 32 The effective credit rate for the second $2,000 of AOTC eligible expenses is as low as 10% for families that are 

only eligible for the refundable portion of the AOTC. 
33

fees and books of $9,550. In such a case, if the family uses the entire Pell Grant to pay for 

tuition, required fees and books, there are still more than $4,000 of AOTC eligible expenses that 

are paid by the parent. Because scholarships used to pay tuition, required fees, and books are not 

taxable, the child’s total income is still equal to the initial $2,000 of wage income, which is well 

below the filing threshold for dependent filers. With $40,000 of wages earned by the parent, the 

family qualifies for the full $2,500 AOTC ($1,000 of which is refundable). The parent’s total 

income tax liability is $508. The family’s total Federal tax and grant benefits (including the Pell 

and the AOTC)) are $4,300, leaving $13,250 (76 percent) of tuition, fees, books, living expenses 

unreimbursed. 
34

Example 1 Example 2 Example 3 Example 4 Example 5 Example 6

Tuition, Required Fees and Books 9,550 4,000 2,000 9,550 4,000 2,000

Room and Board 8,000 8,000 8,000 8,000 8,000 8,000

Total Pell Grants 1,800 1,800 1,800 5,550 5,550 5,550

Pell Used to Pay Tuition, Required Fees and Books 1,800 0 0 5,550 0 0

Pell Used to Pay Living Expenses 0 1,800 1,800 0 5,550 5,550

Expenses Eligible for AOTC (up to $4,000) 4,000 4,000 2,000 4,000 4,000 2,000

Tax Calculation if Student Receives a Pell Grant

Parent's Return

Total Income 40,000 40,000 40,000 20,000 20,000 20,000

Taxable Income1 24,100 24,100 24,100 4,100 4,100 4,100

Tax Before Credits 3,008 3,008 3,008 410 410 410

AOTC 2,500 2,500 2,000 1,410 1,410 1,210

EITC 0 0 0 2,565 2,565 2,565

 Tax Liability of Parent2 508 508 1,008 -3,565 -3,565 -3,365

Student's Return 3

Total Income 2,000 3,800 3,800 2,000 7,550 7,550

Taxable Income 0 0 0 0 1,750 1,750

Tax Liability of Student 0 0 0 0 175 175

Total Tax Liability if Student Receives a Pell Grant 508 508 1,008 -3,565 -3,390 -3,190

Parent's Return

 Tax Before Credits 3,008 3,008 3,008 410 410 410

AOTC 2,500 2,500 2,000 1,410 1,410 1,210

EITC 0 0 0 2,565 2,565 2,565

 Tax Liability of Parent2 508 508 1,008 -3,565 -3,565 -3,365

Student's Return 3

Tax Liability of Student 0 0 0 0 0 0

Total Tax Liability if Student Does Not Receive a Pell 508 508 1,008 -3,565 -3,565 -3,365

Pell Grant

Summary

Increase in Tax Liability (or Decrease in Outlay) 

Because the Student Receives a Pell Grant 0 0 0 0 175 175

Total Tax and Grant Benefits4 4,300 4,300 3,800 9,525 9,350 9,150

Unreimbursed Tuition, Fees, Books, and Living 13,250 7,700 6,200 8,025 2,650 850

Expenses

75.5 64.2 62.0 45.7 22.1 8.5

footnotes on following page

Tax Calculation if Student Does Not Receive a Pell Grant

-- As a % of Total Tuition, Fees, Books and Living 

Expenses

Table 11

Examples of Interaction Between Pell Grant and AOTC in 2011

Head of Household with One Child Who Attends College Full Time

 Child Earns $2,000 Child Earns $2,000

Parent Earns $40,000 Parent Earns $20,000
35

1

 It is assumed that if the child was not attending school, and thus, not eligible for the benefits described, the child would still qualify as a 

dependent relative and appear on the parent's return as such. Thus, total tax benefits are net of any benefit due to filing status or the 

dependent exemption.

2

 Negative values indicate the family is receiving a tax refund. 

3

 Dependents with income are required to file and subject to tax if their income exceeds the standard deduction for dependent filers ($5,800 

for dependents with only earned income). Scholarship income is considered earned income to the student and taxable to the extent that it is 

not used to pay tuition, required fees, or books. 

4 Total tax and grant benefits equals the sum of the AOTC and EITC calculated as if the student did not receive a Pell Grant plus the Pell 

Grant minus the increase in tax liability (decrease in outlay) if the student used some or all of their Pell Grant to pay living expenses.

Table 11, Continued

Examples of Interaction Between Pell Grant and AOTC in 2011

Footnotes

Head of Household with One Child Who Attends College Full Time

Examples 2 and 3 show families that benefit most when the Pell Grant is used to pay for living 

expenses and included in the student’s income for tax purposes. Because the family has 

sufficient tax liability, they receive a $1 tax credit for each $1 of AOTC eligible expense up to 

$2,000 and then they receive 25 cents for each additional $1 of AOTC eligible expenses (over 

$2,000) up to $4,000. For any level of tuition, required fees, and books less than $4,000, the 

family will maximize its tax and grant benefits by using the entire Pell Grant to pay living 

expenses. In Example 2, tuition, required fees and books are $4,000. If the Pell Grant pays for 

living expenses, the student’s taxable income rises to $3,800 (the sum of wages plus included 

Pell Grant) but the student’s tax liability remains zero. The family’s total tax and grant benefits 

is $4,300. Of the family’s total education expenses (tuition, fees, books, living expenses), 

$7,770 (64.2 percent) are not reimbursed. In Example 3, tuition, required fees and books are 

only $2,000 so the AOTC is only $2,000 and total tax and grant benefits are $3,800. 

Examples 4 through 6 repeat Examples 1 through 3 except that the taxpayer has earnings of only 

$20,000 and therefore qualifies for a maximum Pell Grant of $5,550 and an EITC. In Example 

4, where the family’s tuition, required fees and books minus its Pell Grant exceeds $4,000, the 

family can still exclude the Pell Grant from income and have $4,000 of AOTC eligible expenses. 

Because the AOTC is partially refundable, the family is eligible for an AOTC of $1,410. Total 

tax and grant benefits (including the Pell, EITC, and AOTC) are $9,525; only $8,025 (46%) of 

total tuition, fees, books, living expenses are unreimbursed.
36

In Example 5, the family’s tuition, required fees and books are equal to the maximum eligible 

expenses for the AOTC. For this family, any level of AOTC expenses between $2,250 and 

$4,000 results in the same tax liability. This example illustrates the specific case if the family 

pays all $4,000 of tuition out of pocket, includes the full Pell Grant in income and then uses it to 

pay living expenses. The parent’s return looks as it did in Example 4. However, the student’s 

income increases to $7,550 due to the inclusion of the Pell Grant. After allowing for the 

appropriate standard deduction, the student owes income taxes of $175 on $1,750 of taxable 

income and must file a dependent return. The family receives an AOTC of $1410. The family’s 

total tax and grant benefits, net of the additional tax paid by the student, is $9,350.33

In Example 6, tuition expenses are only $2,000. The family maximizes benefits by using the 

entire Pell Grant to pay living expenses so that the full $2,000 is available for the AOTC. The 

effective credit rate on the first $2,000 of AOTC for families whose nonrefundable credit is 

constrained by income is 40%, significantly in excess of the 10% marginal tax rate faced by the 

student.

 33 The effective credit rate for a family whose nonrefundable AOTC dollars are constrained by income is 10%, (40% 

of the 25% credit rate) on expenses between $2,000 and $4,000. Because the student’s tax liability also increases by 

10 cents per dollar of expense, all allocations in this range result in the same benefit. If the family would prefer to

keep the student below the filing threshold of $5,800, thus simplifying the return, only $3,800 of the Pell Grant 

should be allocated to income and the remaining $1,750 of the Pell Grant allocated to education expenses. This 

leaves $2,250 of education expenses to be paid out of pocket and thus eligible for an AOTC. The family will receive 

an AOTC of $1,235, which is identical to the AOTC net of the tax increase to the student as presented in the table. 

If education expenses allocated to the AOTC are below $2,250, the family can increase their allocation to the AOTC 

without increasing the student’s tax liability.
37

Example 7 Example 8 Example 9

Tuition, Required Fees and Books 9,550 4,000 2,000

Room and Board 8,000 8,000 8,000

Total Pell Grants 5,550 5,550 5,550

Pell Used to Pay Tuition, Required Fees and Books 5,550 2,000 0

Pell Used to Pay Living Expenses 0 3,550 5,550

Expenses Eligible for AOTC (up to $4,000) 4,000 2,000 2,000

Tax Calculation if Student Receives a Pell Grant

Filer's Return

Total Income 20,000 23,550 25,550

Taxable Income1 4,100 7,650 9,650

 Tax Before Credits 410 765 965

AOTC 1,410 1,565 1,765

EITC 2,565 1,998 1,678

Child Credit 1,000 1,000 1,000

Total Tax Liability if Student Receives a Pell Grant2 -4,565 -3,798 -3,478

Tax Calculation if Student Does Not Receive a Pell Grant

Filer's Return

 Tax Before Credits 410 410 410

AOTC 1,410 1,410 1,210

EITC 2,565 2,565 2,565

Child Credit 1,000 1,000 1,000

 Tax Liability if Student Does Not Receive a Pell Grant2 -4,565 -4,565 -4,365

Summary

Increase in Tax Liability (or Decrease in Outlay) Because the 

Student Receives a Pell Grant3 0 767 887

Total Tax and Grant Benefits for Education4 6,960 6,193 5,873

Unreimbursed Tuition, Fees, Books, and Living Expenses 10,590 5,807 4,127

 -- As a % of Total Tuition, Fees, Books and Living 60.3 48.4 41.3

Expenses

footnotes on following page

Table 12

Examples of Interaction Between Pell Grant and AOTC in 2011

Head of Household Filer with One Child. Filer Attends College Full Time

Parent-Student Earns $20,000
38

Table 12, Continued

Examples of Interaction Between Pell Grant and AOTC in 2011

Footnotes

1

 It is assumed in these examples that the child is under seventeen and thus qualifies for the child credit and the EITC. 

In these examples the child credit is not affected by the education expenses of the parent.

2

 Negative values indicate the family is receiving a tax refund. 

3 Unlike the case in Table 11, EITC benefits do not depend on the education status of the dependent child, and are 

therefore not included in "Increase in Tax Liability Because the Student Receives a Pell Grant," except to the extent 

that receiving a Pell Grant affects the the value of the EITC.

4 "Total Tax and Grant Benefits for Education" equals the sum of the AOTC calculated as if the student did not 

receive a Pell Grant plus the Pell Grant minus the increase in tax liability (decrease in outlay) if the student used some 

or all of their Pell Grant to pay living expenses. The increase in tax liability includes the effect of including the Pell 

Grant in income on EITC.

Head of Household Filer with One Child. Filer Attends College Full Time

Examples 7, 8, and 9 in Table 12 present the interactions between the Pell Grant and the AOTC 

in the case of a family where the student is a head of household filer with one young dependent 

child. In this case, the Pell Grant is income to the taxpayer which in turn affects his or her tax 

liability. As in Examples 4, 5, and 6, the parent has an income of $20,000, entirely from wages, 

receives the maximum Pell Grant of $5,550, and an EITC. The EITC is not an education benefit 

in these three examples because the qualifying child’s benefits do not rely on his or her education 

status (the student is the parent).34 Because the family in these three examples is in the phase out 

range of the EITC, their marginal tax rate is 25.98%35 and the level of EITC will be affected by 

the amount of the Pell Grant included in income. Each $1 of grant aid added to income will 

increase the family’s tax liability (decrease their outlay) by almost 26 cents. In contrast, they 

receive 40 cents for each $1 of AOTC eligible expenses up to $2,000 of expenses and 20 cents 

for each additional $1 of AOTC eligible expenses (over $2,000) up to a total of $4,000 of 

expenses.36 

 34 In the case of a dependent student, the age threshold for the EITC is increased from 19 to 23, thus the EITC is an 

education benefit in Table 11. Table 12, describes a nontraditional student, for whom the EITC is not an education 

benefit.

35 The marginal tax rate in this example will not hold for all taxpayers or all taxpayers with an EITC. Marginal tax 

rates vary and depend on a taxpayer’s source and level of income and family composition as well as other factors. 36 The 20 cents per dollar consists of 40% ×25% refundable plus 10% nonrefundable. 
39

In Example 7, where the family’s tuition, required fees and books minus its Pell Grant exceeds 

$4,000, the family can still exclude the Pell Grant from income and have $4,000 of AOTC 

eligible expenses. Because the AOTC is only partially refundable, the family is only eligible for 

an AOTC of $1,410. Total tax and grant benefits (including the Pell and AOTC) are $6,960. 

$10,590 (60.3%) of total tuition, fees, books, living expenses are unreimbursed.

In Examples 8 and 9, the family’s tuition, required fees and books minus its Pell Grant are less 

than $4,000. It is not possible for the student to exclude the student’s entire Pell Grant and have 

$4,000 of AOTC eligible expenses. Moreover, because the family’s marginal tax rate is almost 

26%, the AOTC for the first $2,000 of AOTC eligible expenses is more valuable than excluding 

the Pell Grant from income but the AOTC for the second $2,000 of AOTC eligible expense is 

not as valuable as excluding the Pell Grant from income. Consequently in these examples, the 

taxpayer maximizes tax benefits by using the Pell Grant to pay tuition, required fees, and books 

in excess of $2,000 and the remainder to pay for living expenses. 

To maximize benefits when tuition is $4,000 as in Example 8, the family should use $2,000 of 

the Pell Grant to pay tuition, required fees, and books and $3,550 to pay for living expenses. 

This allocation does not maximize expenses eligible for the AOTC, but it does maximize the 

combined benefit of the AOTC and the EITC after accounting for the interaction of these 

benefits with taxable income. The family’s total tax and grant benefits net of the lower refund 

because a portion of the Pell was taxable is $6,193. Of the family’s total education expenses 

(tuition, fees, books, living expenses) $5,807 (48 percent) are not reimbursed. 

In Example 9, the family’s wage income is unchanged but the student attends a school with 

tuition equal to $2,000. The family maximizes its tax benefits by using the entire Pell Grant to 

pay living expenses. The family’s total tax and grant benefits net of the effects of the Pell Grant 

on taxable income is $5,873. Of the family’s total education expenses (tuition, fees, books, 

living expenses) $4,127 (40.3 percent) are not reimbursed.
40

Box 1

Families that Misallocate their Expenses May Leave Money on the Table

Families can choose to use their Pell Grant to pay tuition, required fees and books, or they can use it to 

pay living expenses. In the examples shown in Table 11, the families allocate the Pell Grant to maximize 

their total tax and Pell Grant benefits. But what would happen if the family didn’t get it right? 

Let’s look at the family in Example 5. This family has earned income of $22,000 ($20,000 earned by the 

taxpayer, and $2,000 by the dependent student). The family has $4,000 of expenses for tuition, required 

fees, and books and receives the maximum Pell Grant of $5,550. If the family paid their entire tuition 

with the Pell Grant, the family would not be eligible for any AOTC. If the family put the entire Pell Grant 

toward living expenses, total benefits would be maximized, even though the total amount of tax is higher. 

Families that misallocate their expenses may leave money on the table.

Example 5: This family gets it right. The family uses the Pell Grant to pay the first $5,550 of living 

expenses. This leaves $4,000 of tuition expenses available for an AOTC of $1,410. The student’s tax 

liability is $175.

Example 5a: This time the family uses the Pell Grant to pay all $4,000 of tuition, leaving no expenses 

eligible for the AOTC, and thus, receiving no credit. After accounting for differences in the tax liability 

of the student and the AOTC, by failing to optimize the family forfeits $1,235 in benefits.

Example 5 Example 5a

The Right Approach Tuition, Fees, and Books

Total Pell Grants 5,550 5,550

Pell Used to Pay Tuition, Required Fees and Books 0 4,000

Pell Used to Pay Living Expenses 5,550 1,550

Expenses Eligible for AOTC (up to $4,000) 4,000 0

Total Income Parent 20,000 20,000

Taxable Income 4,100 4,100

Tax Before Credits 410 410

AOTC 1,410 0

EITC 2,565 2,565

 Tax Liability of Parent1 -3,565 -2,155

Total Income Student 7,550 3,550

Taxable Income 1,750 0

Tax Liability of Student 175 0

Total Tax Liability of Family -3,390 -2,155

Total Tax and Grant Benefits2 9,350 8,115

Net Loss from Failing to Optimize Benefits 1,235

1

 Negative values indicate that the family is receiving a refund.

2

 Total tax and grant benefits equals the sum of the AOTC and EITC calculated as if the student did not receive a Pell 

Grant minus the increase in tax liability (decrease in outlay) because the student used some or all of the grant to pay living 

expenses.
41

Box 2

Allocating Expenses is Even More Complicated for Non-Traditional Students

Families can choose to use their Pell Grant to pay tuition, required fees and books, or they can use it to 

pay living expenses. In the examples shown in Table 12, the families allocate the Pell Grant to maximize 

their total tax and Pell Grant benefits. But what would happen if the family didn’t get it right? 

Let’s look at the family in Example 8. This family has earned income of $20,000 and $4,000 of expenses 

for tuition, required fees, and books. They receive the maximum Pell Grant of $5,550. If the family paid 

their entire tuition with the Pell Grant, the family would not be eligible for any AOTC. If the family put 

the entire Pell Grant toward living expenses, AOTC would be maximized, but at the expense of other 

benefits. Families that misallocate their expenses may leave money on the table.

Example 8: This family gets it right. Although they have enough expenses to claim a larger AOTC, the 

family claims just enough education expenses to maximize total benefits after accounting for tax liability, 

the AOTC and the EITC.

Example 8a: This time the family uses the Pell Grant to pay all $4,000 of tuition, leaving no expenses 

eligible for the AOTC, and thus, receiving no credit. After accounting for differences in tax liability, the 

AOTC and the EITC, by failing to optimize they forfeit $1,045 in benefits.

Example 8b: This time the family uses the Pell Grant to pay the first $5,550 of living expenses. AOTC 

is maximized, but after accounting for differences in tax liability, the AOTC and the EITC, by failing to 

optimize they forfeit $120 in benefits.

Example 8 Example 8a Example 8b

The Right Mix Tuition Fees Books Room and Board

Total Pell Grants 5,550 5,550 5,550

Pell Used to Pay Tuition, Required Fees and Books 2,000 4,000 0

Pell Used to Pay Living Expenses 3,550 1,550 5,550

Expenses Eligible for AOTC (up to $4,000) 2,000 0 4,000

Total Income 23,550 21,550 25,550

Taxable Income 7,650 5,650 9,650

 Tax Before Credits 765 565 965

AOTC 1,565 0 1,965

EITC 1,998 2,317 1,678

Child Credit 1,000 1,000 1,000

Tax Liability1 -3,798 -2,752 -3,678

Total Tax and Grant Benefits for Education2 6,193 5,147 6,073

Net Loss from Failing to Optimize Benefits -1,045 -120

1

 Negative values indicate that the family is receiving a refund

2 "Total Tax and Grant Benefits for Education" equals the sum of the AOTC calculated as if the student did not receive a Pell 

Grant plus the Pell Grant minus the increase in tax liability (decrease in outlay) if the student used some or all of their Pell Grant 

to pay living expenses. The increase in tax liability includes the effect of including the Pell Grant in income on EITC.
42

B. Graphical Representation of Interaction

Figures 2 and 3 show the value of Pell Grants and the main education tax benefits for 

hypothetical families at two representative levels of tuition and qualified expenses ($2,500 and 

$7,500) as income is increased. In these examples, the families consist of two married adults and 

their dependent college-aged child. The child attends school full-time. These two levels of 

tuition and qualified expenses were chosen because they are close to the average levels in 2010, 

where $2,500 was the average tuition at public community college and $7,500 was the average 

tuition level at a public four-year college.37 Although these amounts do not explicitly consider 

the value of books and fees (which are also qualifying expenses for the AOTC), the amounts are 

broadly representative of the qualified expenses faced by students at these types of institutions, 

many of whom will have received additional aid from the institutions or from state governments. 

The $2,500 case is important because it captures the experience of families who face limitations 

on aid eligibility due to limited tuition expenses. Families are assumed to have only wage 

income, and are assumed to have a typical level of deductible expenses.38 For purposes of 

computing the Pell Grant, it is assumed that the student is beginning his or her education this 

year, and thus received neither a Pell Grant nor an education credit the previous year. It is also 

assumed that the families have few additional assets. Pell Grant amounts and income tax 

liabilities would vary if these simple assumptions were changed. In these figures, families 

allocate their Pell Grant between living expenses and tuition in the way that maximizes total 

benefits. It is also assumed that the student earns no income and remains below the filing 

threshold for dependent filers.39

Taking Figure 2 as an example, total Federal benefits by provision are shown for a hypothetical 

family with $2,500 in tuition (fees, and qualifying expenses) as income increases. Pell Grants, 

the AOTC, the EITC and the dependency exemption are shown. 

 37 See notes to Table 1. 38 The Office of Tax Analysis routinely assumes that itemized deductions are equal to 18 percent of most forms of 

income. Each family is assumed to itemize deductions only if doing so reduces its Federal income taxes (i.e., if the 

itemized deductions exceed the standard deduction).

39 This assumption simplifies the exposition considerably, but has little qualitative effect on the figures. The effect of 

adding student earnings will be considered at the end of the discussion of Figure 2. 
43

0

2,000

4,000

6,000

8,000

10,000

12,000

0 20 40 60 80 100 120 140 160 180 200 220 240 260

Value of Benefits

Earnings - All Non-Pell Grant income is from Wages 

Figure 2

Value of Federal Income Tax and Pell Grant Benefits for Married Couple 

Supporting One Full-Time Student at Community College

(Tuition and Qualified Expenses $2,500)

(2011)

Additional Benefit from Tax Provisions

(after Pell Grants and AOTC)

Additional Benefit from AOTC

(after Pell Grants)

Pell Grants

All Tax Benefits (AOTC, EITC, Dependent

Exemption, No Pell Grants)

The solid black line (bottom) shows the value of all tax benefits as income increases, ignoring 

any interactions with the Pell Grant. This is equivalent to the case where the family does not 

receive a Pell Grant. The family would be eligible for three main tax benefits, which when 

summed, are equal to the black line. First, the family would be eligible for the non-refundable 

dependency exemption deduction, which increases in value with the taxpayer’s marginal tax rate; 

taxpayers on the alternative minimum tax (AMT) lose the benefit of the personal exemptions, as 

can be seen by the decrease at the highest incomes shown. Second, the family would be eligible 

for the earned income credit, which phases in with the first dollar of wage income, plateaus, and 

then phases out at nearly $36,100 of income. Third, the family would be eligible for a partially 

refundable AOTC. At this level of tuition, the family would be eligible for a maximum AOTC 

of $2,125. At low incomes, the family would be constrained by income tax liability. Only $850 

of the AOTC would be refundable, which means that taxpayers earning less than $35,450 would 

receive less than the full amount of the credit. (Married filers with one dependent child would 
44

not have $1,275 of tax liability before credits until earning $35,450.) At higher incomes, 

between $160,000 and $180,000, the AOTC phases out.

The three areas show the cumulative value of the Pell Grant and successive tax benefits as more 

tax benefits are added. The gray block shows the value of the Pell Grant. Because, in 2011, 

families of dependent students with income of $32,000 or less automatically qualify for a 

maximum Pell Grant, there is a cliff at $32,000 of income where the calculated value of the Pell 

Grant using the formulas is much less than the automatic maximum grant.

The gray area plus the white area combines the value of the Pell Grant and the AOTC. The spike 

at incomes between $20,000 and $30,000 occurs because the nonrefundable portion of the 

AOTC is phasing in with tax liability. (The value of the AOTC continues to rise until $35,450 

but the Pell Grant declines.) The white area does not include the value of the dependency 

exemption deduction or the EITC.40

Finally, adding the gray area, the white area and the striped area together combines the value of 

all benefits, including the EITC and the dependency exemption deduction. For families with 

AGI below $39,000, the additional tax benefits shown by the striped area are mostly due to the 

EITC. For families with AGI above $41,000, the additional tax benefits are exclusively due to 

the value of the dependency exemption deduction which increases with the statutory rate and 

then phases out as the family begins to pay the AMT. If the student had additional earnings 

besides the Pell Grant, the student is likely to have a small amount of tax liability. For example, 

a student who earns $2,000 at a part-time job and receives the maximum Pell Grant would have 

$1,750 of income above the $5,800 standard deduction for dependent filers.41 This income 

would result in additional tax liability for the family of $175. As family incomes increase, Pell 

Grants decrease (and thus the effect of the Pell Grant on the student’s total earnings), until the 

student’s earnings drop below the filing threshold at incomes above $35,000. The total value of 

 40 Few taxpayers would actually receive the values shown by the white area. It is included to highlight the 

distinction between the AOTC and the two age-based tax benefits. (Eligibility for the EITC and the exemption for a 

dependent child are restricted to full-time students under 24 years of age.) 41 The standard deduction is substantially lower for dependent filers with unearned income.
45

benefits would drop at the effected incomes, with an effect on total benefits always below 3

percent. 

Figure 3 repeats Figure 2 for the case where tuition and expenses equal $7,500. Most differences 

between the two figures are relatively small; larger tuition expenses results in a slightly larger 

AOTC (for households not constrained by income tax liability), and a resulting decrease in the 

amount of the Pell Grant that would be included in the income of the student.

0

2,000

4,000

6,000

8,000

10,000

0 20 40 60 80 100 120 140 160 180 200 220 240 260

Value of Benefits

Earnings - All Non-Pell Grant income is from Wages 

Figure 3

Value of Federal Income Tax and Pell Grant Benefits for Married Couple 

Supporting One Full-Time Student at Community College

(Tuition and Qualified Expenses $7,500)

(2011)

Additional Benefit from Tax Provisions

(after Pell Grants and AOTC)

Additional Benefit from AOTC

(after Pell Grants)

Pell Grants

All Tax Benefits (AOTC, EITC, Dependent

Exemption, No Pell Grants)

Figure 4 presents the case of a family consisting of two married adults, one of whom attends 

community college full-time, and their young dependent child. As in Figure 2, the student has 

tuition and qualified expenses of $2,500. However, in this case the student is the taxpayer and 

not a dependent. This difference has a big effect on the amount of student-related benefits 

received by the family. First, the AOTC is the only tax benefit the family receives. The EITC 

and the dependency exemption are not considered tax benefits for education in this case because 
46

the family would still be eligible for these benefits if the parent were not in school. Second, the 

Pell Grant is included as income of the taxpayer (to the extent that it is not spent on tuition or 

other excludable expenses) and not as the dependent’s income. As a result the Pell Grant can 

affect the amount of EITC and AOTC the family is entitled to receive, and the Pell Grant is more 

likely to be taxed. As discussed in the text accompanying Table 12 and Box 2, maximizing 

expenses eligible for the AOTC, may not maximize the combined benefit of the AOTC and the 

EITC after accounting for the interaction of these benefits with taxable income. 

0

2,000

4,000

6,000

8,000

10,000

0

2,000

4,000

6,000

8,000

10,000

0 20 40 60 80 100 120 140 160 180 200 220 240 260

Value of Benefits

Earnings - All Non-Pell Grant Income is from Wages

Figure 4

Value of Federal Income Tax and Pell Grant Benefits for Married Couple with 

One Dependent Child and One Spouse Attending Community College 

(Tuition and Qualified Expenses $2,500)

(2011)

After Tax Value of AOTC + Pell Grant

Tax On Pell Grant

After Tax Value of Pell Grant

Value of the AOTC

The solid black line shows the value of the AOTC as income increases, ignoring any interactions 

with the Pell Grant. This is equivalent to the case where the family does not receive a Pell Grant. 

The family is eligible strictly for the refundable portion of the AOTC until income exceeds the 

filing threshold of $22,700. The AOTC phases out beginning at incomes of $160,000. 
47

The grey areas (dark and light) sum to the statutory value of the Pell Grant, with the darker area 

representing the tax due to the inclusion in income of any Pell Grant in excess of tuition, fees and 

qualified expenses. The light gray area is the value of the Pell Grant net of the tax. This is 

equivalent to the case where the family does not receive an AOTC. 

The sum of the striped region and the gray region is the total amount of benefit this family will 

receive after accounting for all resulting changes in tax liability, including the effect of the Pell 

Grant on the phase-out of the EITC. The spike at incomes between $20,000 and $30,000 occurs 

because the nonrefundable portion of the AOTC is phasing in with tax liability. Recall that 

including a portion of the Pell Grant in income has an effect on a number of provisions. If the 

family is in the phase-out range of the EITC, the additional income would lower the value of the 

EITC (for this family, at a rate of 15.98 percent). The family’s tax liability (if positive) would 

increase (most likely at a marginal rate of 10 percent for families receiving a Pell Grant). 

However the family’s AOTC might also increase if the otherwise allowable credit had been 

constrained by their income tax liability. The extent to which the total area (striped plus light

and dark gray) is less than the sum of the gray areas and the area under the black line (sum not 

pictured) is due to these interactions.

VI. Other Coordination Issues

A. Smaller than Expected AOTC Benefits

As the foregoing discussion illustrates, there are myriad tax benefits and spending programs to 

subsidize higher education. Confusion about the different programs may prevent students from 

receiving the full benefit to which they are entitled. Currently, there are three main tax-based 

benefits for current year expenses: the AOTC, the Lifetime Learning Credit, and the tuition and 

fees deduction. While many taxpayers are eligible for more than one benefit, taxpayers are 

restricted to one benefit per student each year. Recent work examining the selection between 

two tax-based benefits finds that a substantial number of taxpayers do not select the benefit that 
48

offers the largest reduction in tax liability.42 Replacing the existing set of tax-based benefits with 

a single coherent benefit could increase the number of students and families who realize their 

maximum allowable tax benefit. Recent work finds evidence that complex student aid 

applications are a deterrent to program use, and the same is likely true of tax benefits for 

education.

43

Interactions between tax benefits and grant programs are complicated, and may also prevent 

taxpayers from receiving the full benefit to which they are entitled. For students who receive 

both a Pell Grant and an AOTC, the portion of expenses for tuition, required fees and books paid 

with money from the Pell Grant does not count for the purposes of calculating the AOTC. Given 

current information reporting (primarily Form 1098-T) one does not know the extent to which 

taxpayers are optimizing as assumed in the examples in the preceding section, but it is likely that 

many do not.

Another reason that students may fail to realize the full value of their AOTC is that tax-based 

federal student benefits may be offset by increases in the price of attending college. To the 

extent that colleges and universities respond to the AOTC by increasing their prices, the AOTC 

becomes a transfer to institutions of higher learning rather than lowering the cost of 

postsecondary attendance for students and their families. There is little evidence that colleges 

and universities increase tuition in response to student grant aid programs.

44 However, recent 

work finds that some 4-year colleges and universities increase the net price they receive by 

decreasing school grant aid.

45 Lowering grant aid for AOTC recipients may be one method that 

college administrators use to cope with constrained endowments and reduced state support for 

higher education.46 Even if colleges and universities offset the intended cost reduction of 

 42 See Turner (2010A). 43 See Bettinger, et al. (2009). 44 See Long (2006) and GAO (2002). 45 See Turner (2010B). 46 Analyzing 842 university endowments, the National Association of College and University Business Officers 

finds that in FY2008-FY2009 university endowments dropped by an average of 19 percent. The average three year 

growth ending in FY2009 was -2.5 percent. Excerpts from the study can be found at:

http://www.nacubo.org/Documents/research/2009_NCSE_Press_Release.pdf. The Center for the Study of 

Education Policy reports that in FY2008-FY2009, state support for higher education dropped by an average of 3 

percent. Statistics on state level support are available here: http://grapevine.illinoisstate.edu/index.shtml.
49

AOTC, students may still benefit from the programs if schools devote the captured aid towards 

expenditures that students value. For example, schools may increase expenditures on student 

services, capital improvements or make improvements to education quality.

B. Tax Compliance 

Complicated tax and spending provisions and the lack of adequate third-party reporting may also 

lead to non-compliance. Currently, it is possible for non-compliant taxpayers to inappropriately 

reduce their income taxes by claiming an AOTC award that exceeds their maximum allowable

credit. This is possible in part, because there is no third party verification for educational 

expenses that qualify for the AOTC. Schools are required to file Form 1098-T with the IRS, but 

this form does not include the amount of qualified educational expenses. As discussed above

(Section IV), in Boxes 1 and 2 of the form, schools are required to report either “payments 

received” or “amounts billed” to both the IRS and to the eligible student. However, neither of 

these measures accurately characterizes the amount of education spending that qualifies for the 

AOTC. Qualified expenses that count towards the AOTC include tuition and fees but these must 

be reduced by tax-free student grant aid and any distributions from tax-free education spending 

accounts. Other expenses that qualify for the AOTC, such as spending on books, supplies and 

equipment, are not subject to third party verification. Research on tax compliance finds evidence 

of greater tax avoidance in the absence of third party verification.47 Adopting a different 

definition of qualified expenses that includes only third party verified spending, and requiring 

colleges and universities to report this spending directly to the IRS and to the student is likely to 

increase tax compliance by increasing the visibility of these amounts. 

 

47 See, for example, Kleven et. al. (2010), Mazur and Plumley (2007), and U.S. Internal Revenue Service (1996 and 

2012).
50

VII. Options for Increased Coordination

As reflected in the overview above, the various education tax incentives and outlay programs 

under current law are numerous, overlapping, and complex. The programs vary in terms of who 

may receive benefits, which expenses may be covered, and how large an exclusion, deduction, or 

credit may be allowed. In recent years, however, there have been a number of advances that 

have made the process of applying for and receiving direct aid and tax credits easier. 

Prior to the creation of the AOTC, students had to evaluate the Hope Scholarship, LLC, and 

tuition deduction to see which offered the greatest benefit. With the introduction of the AOTC, 

the choice is much simpler. The AOTC always confers the highest benefit, so students that are 

eligible for the AOTC are always better off choosing the AOTC over the LLC or tuition 

deduction.

48 The LLC and tuition deduction remain in the tax code for those students who do 

not qualify for the AOTC, including students attending school less than half-time and students

who have completed their first four years of postsecondary education or who have claimed the 

AOTC for more than four taxable years.

The Administration has also succeeded in enhancing a web-based Free Application for Federal 

Student Aid (FAFSA). Ninety-nine percent of FAFSAs in 2010-2011 were submitted using the 

online application which no longer requires low-income students to provide asset information 

(information that was not used to determine their eligibility). The web form uses skip logic, text 

pop-ups and an IRS Data Match tool that, for eligible students, automatically populates, 

transfers, and verifies applicant tax data with the IRS in real-time, further streamlining the 

process for students and their families. 

In addition, since May 2009, the Department of Education has provided instant estimates of Pell 

Grant and student loan eligibility. These estimates allow students to know in advance what 

 48 In 2009, the first year of enactment, some students eligible for Midwestern disaster relief (which doubled the size 

of the maximum allowable Hope or lifetime learning credit) would have been better off choosing a Hope credit or 

LLC instead of the AOTC. This provision has since expired, so that in 2010 and thereafter, the AOTC confers the 

highest benefit for all students eligible for multiple benefits.
51

education benefits they can expect, increasing the likelihood that these benefits will affect 

enrollment. 

Still, further coordination and simplification of the financial aid system, both direct aid and tax 

incentives are possible. Some options, described in detail below include: 1) reforming the needs 

analysis formula and the FAFSA; 2) adding an estimate of AOTC eligibility when students apply 

for Pell Grants; 3) improving information reporting on grants to insure eligible students receive 

maximum AOTC benefits; 4) excluding Pell Grants from gross income for tax purposes; and 5) 

integrating the delivery of the refundable portion of the AOTC and the Title IV delivery system. 

1. Simplify the Financial Aid Formula and Remove the Asset Test.

Under this option, only information available on tax forms would be used to fill out the FAFSA. 

The asset tests would be eliminated. The current web-based FAFSA has an IRS data retrieval 

tool that allows eligible applicants to access tax data to auto-populate many of the fields in the 

FAFSA application.

49 This greatly simplifies the application process since the data are retrieved 

and, with permission of the student, transferred into the appropriate place on the student’s web 

application. The student does not have to search for his or her records and does not need to 

worry about whether or not he or she is reporting the appropriate amount. Moreover, this 

provides the Department of Education with “point-of-entry” verification that the correct 

information is being reported. This capability increases compliance while at the same time 

decreasing the cost of compliance, a benefit for both taxpayers and students, as well as 

institutions which have to verify information for a share of aid applicants. 

The determination of need under current law, however, requires both tax information and asset 

data for all but the lowest income students. For FAFSA purposes, an asset is valued at the time 

of application and thus is not available on an individual income tax form and can therefore not be 

retrieved, or verified by the web-based application. Yet, studies have shown that eliminating the 

asset information and income adjustments would have little impact on the overall number or size 

 49 Not all students are able to use the data retrieval tool, (e.g. dependent students whose parents are not required to 

file a tax return).
52

of Pell awards.

50 Among all 2009-2010 Pell recipients, only 2.4 percent of parents of dependent 

students and only 2.5 percent of independent students had assets values large enough to influence 

the size of their aid award.

Removing all the asset information and income adjustments would allow students to apply for 

aid using only the information found on their income tax forms. In combination with the IRS 

data retrieval tool, this could make the process of applying much simpler. The application 

process will have moved from a labor intensive process of answering over 120 questions by hand 

to being able to retrieve and auto-populate the application with relative ease. 

2. Web Estimates of AOTC Eligibility

Under this option, students and their families would receive an estimate of their eligibility for an 

AOTC at the same time as they receive an estimate of their eligibility for Pell Grants and federal 

loans. When a student applies for financial aid using the web-based FAFSA, he or she currently 

receives a real-time estimate of his or her Pell Grant eligibility. This proposal would use the 

FAFSA information (prior year IRS data) to estimate his or her eligibility for an AOTC in the 

succeeding year. The estimate would rely on his or her income in the prior year (or family 

income if applicable) and might be different if such income changed significantly in the 

following year. Applicants would need to be warned of this possibility. There would also need 

to be a warning about the possible interaction of the AOTC with other grant aid (such as 

institutional grants). 

Still, by showing the possibility of receiving an AOTC alongside the value of a Pell Grant, 

students would have a better sense of the total level of federal aid that they could expect to 

receive. Unless families are aware of the availability of the AOTC, it cannot encourage 

enrollment. 

 50 See Dynarski and Scott-Clayton (2007) and Council of Economic Advisers (2009).
53

3. Improve Information Reporting

As currently designed, the 1098-T is a valuable source of information for both the IRS and the 

student. But, the design could be improved to make the computation of the credit easier for the 

student and to increase compliance with the rules. 

For the IRS, the current report is invaluable as it identifies the pool of individuals that are 

eligible for the education credits. Only students enrolled at an eligible institution are eligible for 

either the LLC or the AOTC, and only those enrolled at least half time and who have not

completed their first four years of postsecondary education are eligible for the AOTC. Without 

the information report, the IRS would not have a third-party verification of eligible students.

For students, the receipt of a 1098-T serves to notify them that they may be eligible for tax

benefits. The 2011 Instructions for the Student that accompanies the student’s copy of the 1098-

T notifies students that “You, or the person who can claim you as a dependent, may be able to 

claim and education credit on Form 1040 or 1040A for the qualified tuition and related expenses 

that were actually paid in 2011.” 

Unfortunately, the 1098-T falls short in providing the correct information a student needs to 

calculate his or her eligible expenses for the LLC or AOTC. 

First, schools only report tuition and fees required for enrollment (either amounts billed or 

payments received), not expenses for required course materials such as books. Under prior law, 

only tuition and fees required for enrollment were eligible for the Hope credit. Under current 

law, eligible expenses for the LLC are still restricted to tuition and fees required for enrollment 

but eligible expenses for the AOTC also include the costs of required course materials such as 

books. There is no third party verification on the 1098-T for required course materials for the 

purpose of calculating the education tax credit. These materials may be purchased from vendors 

not affiliated with the school. Yet, for the purpose of administering direct Federal student aid, 

schools are required to construct a budget for each student that includes an estimate of course 

materials. These estimates could be included separately on the 1098-T. 
54

Second, taxpayers may only claim expenses that are actually paid by the taxpayer (or taxpayer’s 

claimed dependent) during the tax year. However, because schools are allowed to report 

amounts billed (Box 2) instead of payments received (Box 1), the 1098-T filed for one tax year 

may include expenses that are paid in the following tax year or expenses that are never paid. For 

example, if an otherwise eligible student started taking college classes in January 2011 and he or 

she was billed in December 2010, the student’s school could choose to report the amount as 

billed in 2010 on a 2010 Form 1098-T but if the student did not pay the bill until January 2011, 

then the expenses would not be eligible for a 2010 AOTC. Only if the December 2010 bill is

paid in 2010 would the student be eligible for an AOTC in 2010.51 Alternatively, if a student is 

billed for a class and it is reported as billed on a 1098-T but the student drops the class, he or she 

may receive a 1098-T for a class that was never attended or paid for. Although the student’s

1098-T for the following year would show an adjustment to the prior year amount (Box 4), it

would be too late to help the student file his or her current year taxes. 

Third, even if the 1098-T reported payments received for qualified tuition and required fees for 

all students and if it separately reported related course materials (eligible for the AOTC but not 

the LLC), it would still fall short of easing the computation burden for the student because it 

does not also report payments received for other expenses, such as room and board, that qualify 

for direct student assistance but not tax benefits. As shown above in the examples in Table 11, 

Pell Grants (and other grant aid) may be used to pay room and board, as well as tuition and other 

expenses that qualify for the AOTC. Applying Pell Grants toward room and board may increase 

the amount of expenses eligible for an AOTC and may be advantageous to the student. 

However, the student would need to include the Pell Grant in income. Such a calculation is 

complicated without an information report to guide the taxpayer. If, however, the 1098-T 

provided payments received for qualified tuition and related expenses, a separate line for course 

materials (including books), and a third line for payments received for room and board and other 

expenses eligible for Federal student assistance, then an IRS worksheet could direct a student to 

the tax minimizing calculations and compliant expense amounts to include in income and the 

 51 In the example the student’s classes begin in January 2011. A student may claim an AOTC for 2010 for expenses 

paid in 2010 for academic classes that begin in 2010 or the first 3 months of 2011.
55

expenses to treat as eligible expenses for the AOTC. Although some students are not charged 

room and board by the school because they live off campus or at home, all students receiving 

Federal aid are assigned an estimate of living expenses that are used to determine eligibility for 

Federal aid. In the absence of room and board charges by the school, these estimates could be 

reported.

Under this option, schools would be required to report 1) payments for tuition, required fees, 2)

an allowance for course materials, and 3) payments or an allowance for room and board and 

other expenses eligible for direct student aid. Schools would continue to provide information on 

grant assistance administered through the school. With this information, an IRS worksheet could 

guide the student to appropriately calculate their tax benefits. 

While this option would increase compliance costs on the part of institutions, the dramatic 

increase in aid being directed at these institutions warrants increased oversight. The AOTC is 

expected to cost $22 billion in FY2012 and the Pell Grant Program is over $35 billion in 

FY2012. With nearly $60 billion dollars being used to support postsecondary education through 

these two programs alone, institutions should be full partners in ensuring that eligible students 

are able to maximize their benefits and comply with the tax law. Increasing compliance ensures

that tax benefits are available for those for whom they were intended. 

4. Exclude Pell Grants from Taxable Income

Under section 117 of the Internal Revenue Code as amended by the Tax Reform Act of 1986 

(TRA86), a scholarship or fellowship grant received by a degree candidate is excludable from 

gross income to the extent that it is used for 1) tuition and fees required for enrollment or 

attendance of the student at a qualified educational institution and 2) fees, books, supplies and 

equipment required for courses of instruction at the qualified educational institution. 

Under this option, Pell Grants would again be excludable from gross income even if the grant 

exceeded tuition, required fees, and course-related expenses. As discussed above, Pell Grants 

are targeted at very low-income families. Including Pell Grants that are used to pay living 
56

expenses as income may be a hardship for low-income families that receive Pell Grants and who 

owe tax on these amounts. In support of this option, we note that other low-income benefits used 

for living expenses such as the supplemental nutrition assistance program (SNAP) and temporary 

assistance for needy families (TANF) are not taxable. 

Other scholarships would remain taxable to the extent that they were used to pay expenses other 

than tuition and required fees. This option would increase the coordination of the Pell Grant and 

other tax benefits since the receipt of a Pell Grant would never reduce a student’s AOTC or 

EITC. It would also simplify the education tax benefit calculation for Pell recipients and their 

families since they would not have to calculate how much of their grant (if any) should be 

included in income. 

Figure 5 below shows the benefit of excluding Pell Grants from income for a married couple 

with a dependent child and one spouse attending community college ($2,500 in tuition and fees) 

full-time. The black line shows current law, which includes the effect that including Pell in 

income has on other tax benefits. The dashed gray line shows the extra benefit that would be 

received by moderate-income families if Pell Grants were excluded from income.
57

0

2,000

4,000

6,000

8,000

10,000

0 20 40 60 80 100 120 140 160 180 200 220 240 260

Value of Education Benefits

Adjusted Gross Income (All Non-Pell Grant income is Assumed to Be from Wages)

Figure 5 

Interaction between Pell and Tax Benefits for Married Couple with One 

Dependent Child and One Spouse Attending Community College under Two 

Alternate Stacking Rules 

(Tuition and Qualified Expenses $2,500)

(2011)

Pell Grant

Total Benefits if Pell Grants are Not Taxable

Total Benefits if Benefits are Included in Income to

Maximize Total Benefits (Current Law)

As shown in the figure, some low- and moderate-income families would benefit if Pell Grants 

were not taxable. In this example, families with income between $19,000 and $56,000 would 

have higher total benefits under the option. These amounts would vary by filing status, tuition 

level and other circumstances. Families with the lowest incomes would receive no additional tax 

benefit. In Figure 5, the greatest savings under this option is $955 for families with $34,000 of 

AGI (wages excluding Pell Grants).

Families supporting dependent students would see a reduction in tax to the extent that their 

dependent children had positive tax liability after considering the Pell Grant. However, all 

families would benefit from the simplification. This option would not affect the tax treatment of 

other scholarships. Excluding Pell Grants from income would be expected to cost less than $10 

billion over ten years.
58

5. Integrate Delivery of the Refundable Portion of the AOTC into the Title IV Delivery 

System 

Under this option, the refundable portion of the AOTC would be delivered to the student as a 

boost to their Pell grant rather than as a refundable tax credit. The AOTC-Pell boost would be 

based on prior year tax data as provided on the FAFSA and as verified by the IRS. The 

determination of the size of the AOTC-Pell boost and its delivery would be administered by the 

Department of Education. The nonrefundable portion of the AOTC would not be changed. Like 

the nonrefundable AOTC, the AOTC-Pell boost would only be available for four years. 

There are significant advantages to administering the refundable portion of the AOTC through 

the Title IV Delivery System. One, the AOTC-Pell boost would be available to low-income 

students in a timely manner, and available at a time to influence a student’s decision to enroll. 

Two, it could significantly reduce the compliance burden for the student and his or her family. 

As discussed in Section VIII below, administering an advanced refundable tax credit through the 

IRS would duplicate the efforts of the Department of Education by requiring students to submit 

to a second set of tests for eligibility in order to receive the tax benefit in advance. In contrast, 

under this option, the student would apply for both the Pell Grant and the AOTC-Pell boost using 

only the FAFSA. 

One disadvantage to this program is that some students, for example those whose parent(s) 

experienced a reduction in income, might be eligible for an AOTC-Pell boost based on current 

year data but not based on prior year data. The Department of Education has mechanisms in 

place to address such changed circumstance and other grants and loans may be available in such 

cases. 

VIII. Expedite Delivery of the AOTC -- Advance Refundability 

As shown in Figures 2 through 5, the AOTC serves a wide range of families. Eligible low- and 

moderate- income families primarily receive a refundable credit of up to $1,000 (or 40 percent of 
59

the otherwise eligible amount). For families earning more (until the credit phases out at incomes 

in excess of $90,000 and $180,000 for single and joint filers respectively), the credit primarily 

offsets existing income tax liability.52 Under current law, taxpayers who qualify for the AOTC 

and claim the credit receive the payment as part of their regular tax return filing. Thus, most 

taxpayers with eligible tuition expenses in 2010 would receive their credit in early- to mid-2011. 

For tuition paid in January, this could mean that taxpayers would not receive the offsetting credit 

for as many at 18 months after paying their bill with the education institution, and perhaps as 

much as two years after committing to attend a given academic program. 

Of course, taxpayers with sufficient positive tax liability to adjust their income tax withholding

over the course of the year may be able to receive at least part of their expected credit during the 

same tax year that the expense is incurred. In contrast, taxpayers with no tax liability, that is 

those receiving a refundable credit, cannot adjust their withholding below zero, and therefore 

cannot receive their credit prior to filing a return. As a result, the lag between paying tuition and 

receipt of the tax credit described in the preceding paragraph predominantly affects taxpayers 

with low and moderate incomes. It has been suggested by Lochner and Monge-Naranjo and 

others that this delay can create a barrier to entry for students who are cash constrained, or 

otherwise hesitant to incur an obligation against future tax credits.53 Even for those not 

constrained, the long lag could lessen any incentive effect of the credit on enrollment.

Advanced refundability of the AOTC is occasionally proposed as a way to alleviate these 

problems because it could make credit funds available to students closer to the time when the 

money was actually spent. The money could either be distributed to the student/taxpayer, or 

remitted directly to the education institution. Taxpayers would reconcile the advanced credit 

with their eligible credit amount in their subsequent income tax return filings. They would repay 

amounts provided for which they were ultimately not eligible, or receive additional credits for 

 52 The credit begins to phase out at $80,000. 53 Ellwood and Kane (2000) argue that credit constraints may impede enrollment for some students. Lochner and 

Monge-Naranjo (2008) show document a strong relationship between family wealth and income and college 

attendance and show that this is consistent with binding credit constraints. Belley and Lochner (2007) present 

evidence suggesting the constraints may have become more important in recent years. In contrast, Nielsen, 

Sorensen and Taber (2008) and Cameron and Taber (2004) provide evidence that short-term constraints have little 

impact on education outcomes.
60

eligible amounts not claimed in advance. To minimize repayments, the advance amount could 

be limited to a share of the entire credit or a share of the estimated credit for which the taxpayer 

is eligible. Thus, advance refundability would not affect the amount of the credit for which the 

student was ultimately eligible to claim.

Advance refundability of the AOTC would only, by definition, apply to students attending at 

least half time. Although many of these students would face gross tuition amounts far in excess 

of the value of the tax credits, many others, particularly those attending community college or 

other low cost institutions would be considering attendance at programs for which the credit 

would cover a large share of their tuition costs. 

1. The Argument in Favor of Advance Refundability: 

Some potential students interested in furthering their educations may be cash constrained. These 

students might be unable to enroll even though the resources are expected to be available in the 

future. Providing access to the funds at the time they are needed would eliminate a barrier to 

enrollment while improving incentives for some to obtain additional education. Furthermore, 

asking students to borrow against future tax payments is an inefficient use of student resources, 

and if the student relies on subsidized loans, an inefficient way to use government funds.

2. The Arguments Against Advance Refundability: 

Although there are many good arguments for improving the coordination of expected Federal 

assistance with tuition payment dates, it is unclear that advance refundability of the AOTC could 

be administered efficiently. 

Administering Advance Refundability Would Require Duplicate Needs Analysis and 

Administration: Many of the individuals eligible for an AOTC (and particularly a refundable 

AOTC) will have filled out a FAFSA and therefore, the Department of Education will already 

have a fairly accurate assessment of the applicant’s resources using prior year tax data. 

Moreover, financial aid administrators also have some limited discretion to take other factors 
61

into consideration (such as the refusal of a non-custodial parent to contribute to a child’s 

education) when making an aid award. An advance refundable tax credit would be duplicative, 

and would likely never be as effective as existing Department of Education programs at targeting 

aid to the low-income population.

As seen in Table 7, the low-income population receiving the refundable AOTC is largely the 

same population receiving the Pell grant. This population would be better served by an 

additional outlay program such as that described in Option 5 above (the AOTC-Pell Boost). 

Such a program would achieve the goal of providing funds in a timely manner without requiring 

the student to submit to a second set of procedures, including reconciliation, to ensure that the 

student is in compliance with the law.

It has been suggested that the FAFSA process is burdensome relative to filing for a tax credit, 

and that advanced refundability would provide timely aid with less effort on the part of the 

student. While the FAFSA can be daunting, much of the relative simplicity in obtaining an 

education credit would disappear if the credit amount were advanced and then reconciled at a 

later date. The Department of Education in conjunction with IRS has also made progress on 

simplifying the FAFSA.54 

Advance Refundability is Complex: Advance refundability would be administratively 

challenging and potentially expensive. The IRS or some other entity would need to estimate who 

was likely to be eligible to receive the credit prior to the end of the tax year. The IRS would 

need to issue payments on a rolling basis as individuals made decisions to enroll in a vast array 

of programs with different start dates and tuition rates, at a wide range of institutions that may 

vary in their ability to participate in administering the payments, if required. A much more 

precise analog to the 1098-T would need to be developed so that the IRS could track spending, 

ensure compliance, and issue funds in a timely way. The 1098-T is currently issued once a year 

based on data available at a given point in time, and is insufficient to support the implementation 

of advance refundability.

 54 These efforts are documented in U.S. Department of Education (2009), Report to Congress on Efforts to Simplify 

the Free Application for Federal Student Aid (FAFSA).
62

Additionally, the IRS would be required to develop procedures for the distribution of the 

advanced funds. Options would range from mailing checks to the individuals to advancing the 

funds to the education institutions and integrating the advanced amounts into the student’s 

financial aid packages.

Advance Refundability is Expensive: First, IRS would face direct costs associated with 

distributing the money and issuing checks to individuals or institutions. Second, the 

administration of advance refundability would require new procedures for the reconciliation of 

funds distributed with the funds for which the person was actually eligible at the end of the tax 

year. Depending on the nature of the advanceable program, advance refundability of the AOTC

could involve reconciling millions of returns and issuing millions of checks. Taxpayers might be 

asked to repay advanced funds in some cases, which could create hardships for some. Any 

provision to hold harmless those taxpayers whose circumstances changed would increase 

program costs. Fear of a repayment obligation could limit the appeal of the program. 

Furthermore, the IRS would need to integrate this new program into existing processing and 

enforcement programs. Treasury expects that advanced refundability of the AOTC would 

increase noncompliance, partially due to the increased complexity of the credit. Moreover, if the 

refunded amounts were relatively small compared to audit thresholds, it is possible that much of 

the noncompliance would go unchallenged. 

3. Past and Future Experience with Advanceable Credits

To date, Federal experience with advanceable credits has been limited. The two main 

advanceable credits are the Health Coverage Tax Credit (HCTC), which pays a large share of 

health insurance premium costs for certain qualified displaced workers, and the advance payment 

of the Earned Income Tax Credit (EITC), which prior to repeal allowed eligible taxpayers with 

children to receive up to sixty percent of their EITC in their regular paychecks. The HCTC has 

several administrative requirements to determine eligibility and premiums for a very small 

population of participants, and is therefore not a good model to use as a design for expanding to 
63

larger populations.55 The advance payment option for the EITC was unpopular with taxpayers 

even though evidence suggests that many eligible households are cash constrained during the 

year. The reasons for low utilization are not fully understood but may include lack of awareness, 

preference for lump sum payments, fear of being forced to make a sizable payment to the IRS if 

circumstances change, and distaste for discussing participation in a tax credit program with their 

employers. IRS efforts over the years to improve participation through outreach were not 

successful. At the time of repeal, around one percent of the eligible were participating.56 

Public laws 111-148 and 111-152, collectively referred to as the Affordable Care Act (ACA), 

provide for a refundable tax credit for health insurance coverage purchased through a federal or 

state exchange. Notably, the health insurance market does not currently have a widely available 

and large-scale grant program analogous to the Pell Grant to help low-income families purchase 

health care. Thus, it was necessary to create a new mechanism for enrolling families in 

insurance coverage and delivering subsidies at the time that they are paying for health insurance. 

Health insurance exchanges will use the most recent available tax data, along with other more 

recent information, to determine an advance payment. The exchange will enroll an individual in 

a plan of their choosing and the Treasury will send payment directly to the insurer. At the end of 

the year, individuals will be required to reconcile their advance payments on their tax returns. 

Individuals who receive an advance payment that exceeds the end-of-the-year tax credit amount 

will be required to pay back the difference up to a limit, while those who receive an advance 

payment that is less than the end-of-the year credit will be able to claim the full difference. 

IX. Volunteer Service Requirement as a Condition of AOTC Eligibility

The American Recovery and Reinvestment Act of 2009 (ARRA) calls for the Secretary of the 

Treasury and the Secretary of Education to investigate the feasibility of implementing a 

requirement to fulfill a volunteer obligation in order to be eligible to receive this credit. This

 55 Administrative hurdles to management are described in GAO (2004). 56 Participation and noncompliance are described in GAO (2007). IRS efforts to increase awareness are described in 

IRS (1999).
64

section provides an analysis of what the requirement could mean to the relevant stakeholders: the 

students who would perform the community service; the taxpayers who may claim the credit on 

behalf of the student; the educational institution the student may attend; the Internal Revenue 

Service, which administers all tax provisions; and the local charitable organizations at which the 

students would volunteer. 

The law mandating the study does not specify the characteristics of the service requirement, 

including the nature of the volunteer obligation, the relationship between the volunteer obligation 

and the resulting benefits (for example, if the recipient of a relatively small AOTC would have 

the same obligation as student receiving the maximum AOTC), how it would be administered 

(for example, if students could self-report, or if the reporting would be done by the charity or by 

the institution attended by the student), or any other characteristics of the requirement. Therefore 

this section begins by outlining the components that a service requirement might entail. The 

section continues with a description of some of the challenges to successful implementation of a 

service requirement within a tax credit. This includes consideration of the potential impact of a 

service requirement on tax compliance and on the effectiveness of education tax credits at 

supporting families with education expenses. For this analysis, it is generally assumed that the 

credit would only apply to the AOTC, and not the LLC, although some discussion about the 

variation in the size of the credit is included. 

As part of preparing this report, Treasury requested public comment on the requirement and what 

it would mean to stakeholders. Treasury received more than sixty responses, many of which 

were extremely thoughtful and insightful. High-quality analyses were received from groups 

representing universities, researchers, the service learning community, and from taxpayers. 

Their comments are integrated throughout the text and then presented in detail in a separate 

section toward the end of the discussion. With few exceptions, the respondents were 

overwhelmingly opposed to a volunteer service requirement.
65

A. A Framework of a Volunteer Requirement

Any proposal to add a volunteer requirement for receipt of an education tax credit would likely 

contain the six components described below. Within this framework, there is a great deal of 

flexibility about the level of oversight, the level of engagement by students, and the purpose of 

the credit. Although it is easiest to think of the administration of a complex program by a 

university or other large institution, it is important to remember that the requirement would also 

apply to students at small technical schools and at for-profit institutions, both of which cater to a 

less traditional student population. The six components are as follows:

1. Definition of a legitimate program. Criteria would be established that define a legitimate 

volunteer program and legitimate activity. 

2. Students self-identify and choose to participate. Students would self-identify that they are 

likely to be eligible for a tax credit based on the estimated income and education 

expenses,57 and decide to pursue a volunteer opportunity.

3. Students and volunteer opportunities are matched. The nature of the match is part of the 

program design. For example, students could be required to find volunteer opportunities 

on their own, work in conjunction with an office within the university (or other 

educational institution), or coordinate with a charity-based office. It could be that 

educational institutions are mandated to ensure that sufficient legitimate opportunities 

exist for all students (through outreach and coordination), or the responsibility for finding 

a valid opportunity could reside elsewhere.

4. Students perform the community service, presumably to the satisfaction of the charity.

 57 Income means income on the tax return; thus, for dependent students, this would be income on their parent’s 

return and for individuals paying for their own education, or the education of their spouse, this would be income as 

it appears on the individual’s own return. Furthermore, education expenses would be net of grant or scholarship aid 

as defined in the tax code.
66

5. Completion is reported and taxes returns are filed. Reporting requirements must also be 

part of the credit design. The nature of the reporting could be through the educational 

institution (perhaps on a redesigned 1098-T), by the student or the taxpayer claiming the 

student (perhaps simply self-reported), by the charitable organization (perhaps on an 

additional information return), or by multiple parties. 

6. IRS processes returns, which would include conducting enforcement activities.

The purpose of presenting a barebones framework is to ensure that the following discussion 

covers all major implementation challenges and is sufficiently focused on the integration of all 

parties. Establishing a requirement is certainly possible, but it is less obvious that sufficient 

safeguards could be created as part of the requirement to ensure access to opportunities, 

accountability, and a valuable experience to the students and charities involved. It is also not 

obvious that IRS could administer a meaningful requirement in a manner that is consistent with 

IRS’s primary mission to administer the tax system and that meets reasonable standards of 

compliance and efficiency. 

B. Challenges:

1. Definition of a legitimate program:

Successful administration of a volunteer requirement depends on a shared understanding of the 

program’s rules and procedures by the main stakeholders: taxpayers and volunteers, the 

organizations that accept the services of the volunteers, and the education institutions the 

volunteers attend. It is not the purpose of this report to establish policy goals or to construct a 

vision statement in support of such goals. However, without a well-articulated statement of these 

policy goals, analysts will not be able to establish criteria for judging the success of the program 

or its cost efficiency.

On a more fundamental level, defining a program requires articulating the kinds of activities that 

would be permissible and not permissible. It would be necessary to develop criteria that would 
67

mandate the minimal effort level required for receipt of the credit. Linking a single day’s 

charitable activity to receipt of a $2,500 credit may belittle the charitable effort and would not 

warrant the infrastructure required for administration of this credit. On the other hand, a 

requirement that is too burdensome would discourage participation by students who may find it 

more efficient to increase their hours of paid employment and forego the credit. Not all students 

receive the full credit, which suggests that some prorating of the required effort level may be 

appropriate. Criteria would also be necessary to determine which organizations would be 

considered valid for credit purposes. Should the list be restricted to public charities, or should 

individuals be able to meet the requirement at religious organizations, political organizations,

sports organizations, or other groups of their own choosing? If the requirement were to be 

administered by the educational institutions, should these institutions be required to accept 

activities that may be in opposition to the charters of their institution? Policies at existing 

volunteer programs and service learning programs (such as AmeriCorps58 and those affiliated 

with Campus Compact59) may provide some insight into how many of these questions should be 

answered. However, establishing a program of this magnitude (100 times larger than 

AmeriCorps) that also integrates the procedures and policies governing tax administration will 

require unique and creative solutions.

2. Students self-identify and choose to participate

Education credits are received by taxpayers as part of the ordinary tax filing process after the 

close of the year. The actual volunteer effort would occur prior to the end of the tax year, thus 

largely before annual income is known to the taxpayer. Many, but not all taxpayers can safely 

predict whether or not they will be income-eligible for the full credit, but others cannot due to the 

phase-out of the credit beginning at $80,000 ($160,000 for joint filers) or due to the phase-in of 

the nonrefundable piece of the credit (which is dependent on income tax liability). 

 58 AmeriCorps operates two programs that place individuals in community service positions, pay a stipend, and 

upon completion of the program, a college scholarship. The website is at http://www.americorps.gov/. 59 Campus Compact is “a coalition of University presidents committed to promoting service learning opportunities 

on campus.” The website is at http://www.compact.org/.
68

It may also be the case, particularly in the first years after enactment, that students and families 

might not know about the additional requirement for receipt of the credit. To ensure awareness 

of the requirement by students and their families, the education institutions and IRS would need 

to conduct outreach well before the end of the tax year. Furthermore, because a large share of 

the student population in any given year is new to the AOTC, and thus, would be new to any 

volunteer requirement, the necessity for at least some outreach would always be present.

Some students who qualify for an AOTC under existing rules may opt out of completing the 

volunteer requirement or be unable to complete the volunteer requirement, thereby forfeiting up 

to $2,500 of federal aid per year.60 Comments from respondents and the Community College 

League of California (2004) suggest that those who would struggle hardest to fulfill the 

requirement, and thus maintain eligibility for the assistance, would be those with the fewest 

resources, particularly those with large commitments outside the classroom.61 This potential 

outcome would be in conflict with the Administration’s dual goal of making college more 

affordable and increasing access.62

3. Students and volunteer opportunities are matched.

Establishing criteria for how willing students and volunteer opportunities would be matched is an 

important feature of the program design. Challenges to consider include ensuring that sufficient 

legitimate opportunities exist in a given region for all students who are potentially eligible and 

interested in participating, and ensuring that the new credit does not undermine existing 

programs. Representatives from the service learning community described the ongoing 

challenges faced by their institutions in creating opportunities, and in nurturing the personal 

relationships developed between the staff at local charities and their institutions. Respondents 

from rural programs highlighted the lack of local infrastructure, and sometimes the limited need 

for volunteers. Large state universities may have tens of thousands of students but be located in 

 60 Many but not all of these students would have been eligible for the smaller tuition deduction or lifetime learning 

credit.

61 Those most likely to be affected are students with dependents, students who work more than 20 hours per week, 

and students who do not have access to transportation. 

62See http://www.whitehouse.gov/blog/2010/10/13/american-opportunity-tax-credit-and-presidents-event-today and 

http://www.whitehouse.gov/blog/2011/03/23/call-action-college-completion.
69

small communities far from a population center.63 A 2003 study of 21 “high quality” volunteer 

programs found that more than half of their study participants indicated that they did not need 

more volunteers, and the remaining nine had specific skill and scheduling requirements.64 These 

challenges to assuring that sufficient positions exist are exacerbated once we consider that many 

students would be unable to perform their required service during normal business hours due to 

the nature of their academic programs (nursing students and others in highly structured training 

programs would be in class most days), and additional responsibilities (most students have jobs, 

and non-traditional students may have family commitments). 

If the matching is done informally by students, such that each student seeks out a suitable 

volunteer requirement on his or her own, success for some students may be limited by their

youth and inexperience. It is not clear what fairness concerns would dictate for students who 

made a legitimate effort to fulfill the requirement but were unable to do so due to insufficient 

opportunities or insufficient job-seeking skills, and how these students could be distinguished 

from those whose failure to fulfill the requirement may be less sympathetic. 

If instead the matching were done in conjunction with an office within the education institution, 

by the government, or through cooperation among the non-profits, questions regarding how these 

responsibilities should be funded would arise. Should these costs be borne by the charities that 

presumably would benefit from the community service provided? Should these costs instead be 

absorbed by the education institutions? What is the appropriate level of responsibility for the 

education institutions, particularly those that are small or for-profit? 

4. Students perform the community service.

Although this portion of the framework would seem straightforward, there may be compliance 

issues to resolve in certain cases. The earlier discussion suggests that this requirement should 

represent a non-trivial time commitment. Thus it should be expected that some individuals 

 63 For example, the main campus of the University of Connecticut has 16,000 undergraduates and is located in a 

town of fewer than 11,000 people (some of the 11,000 represents students who live in the community).

64 See the Grantmaker Forum on Community and National Service (2003).
70

would fail to fulfill their obligations. Ensuring only entitled students received the credit may be 

challenging. For example, it would seem likely that some students would volunteer at an 

organization assisting a community to which the student belongs. For example, students may 

volunteer in programs affiliated with their own house of worship or at a youth organization in 

their home town. In these cases, the relationship between the organization and the student and 

between the organization and the student’s parent (the taxpayer) may be long-established and 

close. It is likely that the charities would feel pressure to “check off” that the obligation was 

completed even if the student did not do so – pressure may be particularly intense if it were 

perceived that the student’s parent would “lose” the aid. Commenters expressed some concern 

about the potential subjectivity of any standard of completion. 

Other issues involve the costs and risks to the organization of accepting volunteers, particularly 

if accepted in great number. Charities could incur costs in many areas: increased security and 

asset protection, background checks, training and oversight, construction of appropriate projects 

for the volunteers that may not be the best use of the manager’s time, and recordkeeping. One 

respondent described the large variation in the assets (and liabilities) that her volunteers bring, 

which dictates the level of oversight required and the objective value of the volunteer’s time to 

her organization. At least some charities may find that these costs exceed the potential benefits 

from accepting AOTC volunteers and decline to participate.

5. Completion is reported and tax returns are filed.

A volunteer requirement could be designed with either minimal or very precise reporting 

requirements. At a minimum, taxpayers could be asked to self-report to the IRS that they have 

fulfilled the requirement, perhaps as a check-box on their return. This minimal level of reporting 

would be the easiest for IRS to administer, but is likely to lead to noncompliance which would 

undermine the legitimacy of the requirement. Another option would be augment the check-box 

with additional reporting on the Form 1098-T, which is already issued to most students. The 

education institutions could be required to determine if the requirement was completed before 

issuing Form 1098-T, but this would impose burdens on these institutions, and potentially insert 

the institution’s financial aid office into a relationship outside the normal purview. A third 
71

option would be to create an additional reporting mechanism, a new Form 1098, for the charities 

to fill out and submit. It is well-known that taxpayer compliance improves when there is reliable 

third-party reporting, but increasing reporting must only be considered after an evaluation of the 

burden it would impose, and if a sufficiently high level of accuracy can be expected from those 

who report. 

 

6. IRS processes returns, which would include conducting enforcement activities.

Discussions were held with IRS regarding the potential IRS role in administering this 

requirement. IRS stressed that the IRS is first and foremost a tax administration agency, and 

should therefore not have a role in making subjective determinations regarding satisfactory 

completion of a volunteer requirement. For the same reasons, the IRS should not manage the 

commitment and certification process.

If additional information were included on a revised Form 1098-T, or even a new form, the IRS 

would be able to process the returns in a manner similar to the processing of other provisions, but 

serious challenges to successful and efficient processing would exist. Challenges include timing, 

noncompliance, and additional resource cost.

Timing: Matching of information returns with tax return data can take twelve to eighteen 

months. Thus, the main enforcement tool available to the IRS would be an audit conducted well 

after the return claiming the benefit has been filed. 

Furthermore, for the IRS to administer this credit, it would need to be on a tax year calendar like 

other income tax provisions and not on an academic calendar. This mismatch between the 

calendars of academia and the IRS could create challenges for students who would have very 

limited time to complete a requirement recognized by their university, and would put pressure on 

Form 1098-T processing by the institutions (if required to administer the requirement).

Specifically, the tax year for individuals begins in January and finishes at the end of December. 

In contrast, for most students, the academic year begins with the fall semester in August or 
72

September and continues through the following summer. New students would have only three or 

four months left in the tax year in which to find a placement and complete the volunteering for 

that year. The education institution would also be rushed. Currently, the education institution 

mails the 1098-T to students in the January following the end of a tax year. The 1098-T contains 

billing information from the first part of the current academic year, and the last part of the 

previous academic year. Education institutions have most of the fall to fill out the 1098-T and 

transmit the information to the students and the IRS because in most cases, the amounts on the 

1098-T will be known relatively early in the fall semester, if not before. If a volunteer 

requirement were put in place, students might still be working on their required volunteer effort 

throughout the fall semester, (returning students may have completed the requirement in the 

previous academic year (but still in this tax year), new students would most likely not have had 

this opportunity), but the January deadline for sending the Form 1098-T could not be pushed 

back. This, in turn would put pressure on Form 1098-T processing by the institutions.

Noncompliance: Noncompliance with the rules governing education credits has been discussed 

in an earlier section along with details about the limitations of the Form 1098-T. Adding an 

additional requirement, particularly one with as many complications as this one, is likely to 

increase noncompliance because it creates an additional restriction on eligibility65. Presumably 

adding this requirement would create the need for a larger compliance presence in this area, with 

the associated costs.

Resource Cost: IRS would face a number of costs to implementing a volunteer requirement. 

These include those related to the following: a) modification of the Form 1098-T or creation of a 

new form, b) integration of the new or modified form in the IRS’ electronic filing systems, and 

transcription costs for those returns that are submitted on paper, c) the processing and storing of 

additional data, d) the matching of additional data elements during processing, and e) conducting 

outreach and answering taxpayer questions about the requirement. Furthermore, since it is 

expected there would be a substantial amount of noncompliance, IRS would face costs related to 

improving fraud detection systems, and the general increased compliance presence.

 65 For example, some individuals who may be compliant under current law might continue claiming the credit 

without legitimately fulfilling the volunteer service requirement. 
73

The preceding two sections have identified key challenges in designing and administering a 

volunteer service requirement within a tax credit and demonstrated that although it may be 

feasible to add a requirement of this nature to the existing AOTC, it is most likely not feasible to 

do it in a way that would be consistent with good tax policy. A volunteer requirement would be 

burdensome to the institutions administering the credit, be burdensome to students and taxpayers, 

lead to noncompliance by taxpayers and charities, and increase IRS administrative costs. 

Furthermore, it is not clear that such a requirement would actually achieve the likely policy goals 

of increasing civic engagement or increasing resources available to the charities.

C. Public Comment:

In connection with this study, Treasury solicited public comments on the feasibility of 

implementing a volunteer requirement.66 The following questions were asked:

1. Should students be required to fulfill a community service requirement for receipt of an 

education credit? Why or why not?

2. If there were a community service requirement, should the institutions providing postsecondary education and training (hereafter, colleges) be required to administer it? 

Please elaborate.

3. If there were a community service requirement, and the colleges were required to 

administer the requirement, what would be the main operational and administrative 

challenges the schools would face in implementing this requirement? Topics to address 

include, but are not limited to:

a. How would colleges ensure that there are meaningful community service 

opportunities available for all students? 

 66 Notice 2010-7021, released on Tuesday, March 30, 2010 is found on page 15772 of the Federal Register, vol 75, 

No.60, at http://edocket.access.gpo.gov/2010/pdf/2010-7021.pdf.
74

b. How would colleges ensure that eligible students are identified and able to claim 

the credit while students who failed to fulfill the community service requirement 

are not able to claim the credit?

c. How could existing infrastructure on campuses help or hinder the implementation 

of this requirement?

d. If administration of this credit involved additional reporting, perhaps on a revised 

IRS Form 1098-T or were tied to the campus-based work study program, how 

would institutions be affected?

4. What challenges would students face in fulfilling this community service requirement if it 

were adopted?

A total of 62 responses were received from a variety of stakeholders. Most responses were 

provided by university staff, including professors, program managers, deans, and representatives 

from financial aid offices. They represented the full range of institutions, including elite 

colleges, state universities, community colleges, and trade schools. Additional responses were 

received from trade associations and other consortia representing university interests in general 

and community service interests specifically. Ten responses were received from private citizens, 

most of whom had experience supporting a student or paying for their own educations. Finally, 

one response was received representing tax preparers. In addition to these responses, interviews 

were conducted with representatives from one non-profit and with educators and administrators 

involved with service learning.

67

All but four respondents were strongly opposed to requiring a volunteer commitment for receipt 

of the federal education credits, though the majority of respondents also stated that encouraging 

volunteerism was an important policy goal. Very few thought that the requirement should be 

 67 Service learning programs are academic programs or classes that integrate a volunteer or community service 

component into the curriculum, along with assessment tools and writing assignments. Critical to the successful 

implementation of the programs is an ongoing relationship between the volunteer organizations where the students 

serve and the teachers, professors, and administrators in the education institutions attended by the students. More 

information about service learning is available from the National Service Learning Clearinghouse at 

http://www.servicelearning.org/what-service-learning.
75

administered by the universities,68 which is consistent with the fact that this sector provided most 

of the responses. 

Question 1 – Should There Be a Voluntary Service Requirement? 

The overwhelming majority of respondents thought that requiring a volunteer commitment for 

receipt of federal education credits was undesirable even though most also stated that 

encouraging volunteerism was a legitimate policy goal. The two responses in support of a 

service requirement were brief: one stressed the importance of giving back, and the second 

described the potential for the credit to increase the visibility of local charities. Two respondents 

were ambivalent: they were not opposed to the idea of a requirement in principle, but were 

concerned that in practice the credit would be unadministrable or too burdensome to students. 

Those in opposition provided more detail. Their reasons for opposing the credit varied and are 

presented thematically below.

It Isn’t Volunteering. Many respondents opened with strong statements about the nature of 

volunteerism, and how the relationship between donor and donee no longer holds once the 

activity is required. Respondents described a requirement as “forced volunteering,” a “paradox” 

or “not community service at all.” Two respondents likened the requirement to slavery. Others 

provided more subtle arguments on how requiring the service could change the quality of the 

work effort (and thereby diminish the benefit to the charities for whom the work was done), or 

the attitude of the volunteers (who might become less likely to volunteer again in the future).

A Service Obligation Is Inconsistent with the Purpose of the Credits. Some respondents opened 

their comments by reiterating the purpose of the existing credits, which is to assist families with 

education expenses and thereby encourage attendance and persistence. In support of their 

position, they made reference to the original discussions in the 1990’s by Congress and the 

Clinton administration that surrounded the education credits’ introduction. These respondents 

stated that other goals (such as encouraging a deeper connection to society or increasing 

 68 Most respondents referred to universities, and not educational institutions in their comments, although some 

respondents did come from smaller institutions.
76

assistance available to local charities) may have merit, but because these goals are inconsistent 

with the stated purpose of the credits, they should not be linked to receipt of the credits. 

Respondents writing on this theme further stressed that the volunteer service requirement would 

make it more difficult for students to claim the credits and thereby weaken any positive impact 

the credits could have on attendance or persistence.

The Requirement Would Add Complexity. Respondents noted that the existing education credits 

are already very complicated, with many individuals “leaving money on the table” due to this 

complexity. Additional rules and requirements would exacerbate this situation and undermine the 

administration’s goal of increasing access to higher education. As an example, respondents 

described individuals who would not know that they were potentially eligible for a credit or 

know the size of their credit until after the tax year is over and their income is determined. At 

this point, however, it would be too late for such individuals to do any required volunteering. 

Other respondents stated that the purpose of the Internal Revenue Service is to administer the 

collection of taxes; administering a volunteer service requirement would be different from most 

everything else the IRS does and outside the IRS’ area of expertise. The respondents were 

concerned that this requirement would put IRS in the position of making value judgments about 

taxpayer behavior and recommended that IRS responsibilities remain restricted to its central 

mission of collecting taxes.

A Volunteer Service Requirement Would Be Unfair. Some respondents noted that the challenge 

of fulfilling any volunteer service requirement would be greater for some students than for others 

and the most affluent students would face no volunteer requirement at all. The unequal burden 

struck these respondents as unfair. These respondents reminded Treasury to consider the large 

number of non-traditional students, disabled students, students in trade schools, and those who 

might have too many additional responsibilities to complete the volunteer requirement; such 

students could be forced to opt out of the tuition assistance. A responding professor stated that 

his work shows that those most likely to fulfill a volunteer requirement, and thus receive the 

assistance, would be those in the more affluent portion of the credit-eligible population. 

Additional respondents noted that not all students would have equal access to suitable volunteer 

opportunities due to the resources and locations of the schools they attend, and the characteristics 
77

of their academic programs. For example, some students attend universities with wellestablished volunteer programs in areas of the country where many non-profits are active. Other 

students attend smaller programs without these resources and opportunities. For example, one 

respondent compared the resources at a large university to those at her small-town beauty school. 

Some students do not have cars and would have limited access to off-campus opportunities. 

Some students, including nursing students, attend tightly structured programs that may include 

on-site training during much of the workday. Students in these programs would find fulfilling a 

volunteer requirement much harder than students in more flexible programs. Some students are 

disabled, or have children of their own. Respondents worried that overall, those who would 

struggle the most to fulfill the requirement would be those with the fewest resources. As stated 

by one respondent, from this perspective, the volunteer requirement is potentially regressive.

There Are Insufficient Meaningful Opportunities Available for Students. Many respondents 

stated that there would most likely be insufficient opportunities in some locations for students to 

fulfill this requirement even if intentions were good. Respondents noted that many American 

universities and colleges are in rural areas. Local charities in these areas would not have the 

infrastructure to provide opportunities to the large population of students needing to fulfill the 

requirement. Matching students with opportunities, particularly students who do not have 

transportation, have disabilities, or have limited opportunities to perform the service during 

normal business hours would be challenging, if not impossible. 

The Benefits to Charities are Mixed. Respondents provided insightful comments on the effect 

this requirement would have on the charities receiving the volunteers. Naturally, the number of 

volunteers available to many charities would increase if a volunteer requirement was mandated, 

and a larger pool could be advantageous to charities struggling to meet their charitable goals. 

However, it was not clear to those responding that the benefits from increasing the volunteer 

pool in this way would be sufficient to induce the charities and community organizations to 

absorb the influx of students. Integrating new volunteers imposes certain direct costs on the 

charities. Costs cited include those related to providing additional training to volunteers and 

staff, conducting background checks, providing supervision and oversight of volunteers, and 

increasing exposure to risk and liability. In addition, there would be administrative costs to 
78

managing the volunteers, including the costs of hiring additional staff, and completing any 

reporting requirements. 

It was also suggested that charities might be pressured to increase their volunteer programs to 

absorb the influx of students, which could detract from their mission. One respondent suggested 

that the placement and oversight might simply “overwhelm” the agencies, and leave them 

spending more of their limited time and resources on administrative duties, rather than serving 

the populations who need their assistance. Another respondent echoed these concerns when 

describing her own experience with volunteer workers. This respondent’s organization, like 

many other charitable organizations, “hires” teen volunteers from within the community served. 

Although some volunteers were excellent, others were less able -- creating meaningful volunteer 

opportunities for these teens is a challenging and often time-consuming process. 

There was one dissenting opinion on this topic presented by a respondent favoring a volunteer 

requirement. This respondent thought that charities would benefit. He described his experience 

with a Disney-based incentive program – Disneyland provided free tickets to individuals who 

showed that they had done some recent volunteering. This respondent was pleased with the 

influx of volunteers his organization witnessed as a result of Disney’s program, and credited this 

influx with increasing local awareness about the charity he serves.

A Requirement could affect Existing Opportunities. Many respondents wrote at length about the 

value of community service – to the charities served, to the wider community, and to the 

individuals who volunteer – and the importance of encouraging individuals to engage in their 

community at all stages of their life. However, as described above, the majority of the 

respondents doubted that a tuition tax credit was a sensible way to achieve this goal. They 

argued that a tuition tax credit was too narrow because it only targeted credit-eligible students 

and not potential volunteers at other stages of life or for whom a tuition credit is otherwise 

irrelevant. Respondents described existing campus-based community service programs (e.g.,
79

service learning opportunities, AmeriCorps, and the Federal Work-Study Program69) and 

suggested that government resources would be better spent on providing additional support to 

these programs than on creating the infrastructure for a tuition credit program. Respondents 

wrote that in many cases, the administrators of the existing programs have already developed ties 

to local organizations for student placement, and have extensive knowledge about local needs. 

As described by the respondents (some representing these programs), these programs are very 

successful and should be encouraged. Respondents expressed concerns, however, that a 

volunteer requirement would divert limited resources away from these programs as education 

institutions felt pressure to accommodate the credit-seeking students at the expense of students in 

other programs.

Question 2 - Credit Administration: Should the Schools do it?

Most respondents were opposed to the schools administering any volunteer requirement. This 

result was not completely unexpected because nearly all of the respondents were school 

administrators or otherwise connected to higher education. They had two main reasons for their 

opposition, which are discussed below. 

Inappropriate Role for the Schools. First, many respondents thought it was inappropriate for the 

schools to be involved in a “discussion” between the taxpayer and the IRS (beyond potentially 

reporting dollar amounts). Respondents commenting on this were particularly opposed to a 

university role in assessing the legitimacy of any particular volunteer activity and stated that this 

kind of role occurs nowhere else in the tax code. Respondents suggested that university 

administration would mean that universities were assigned an enforcement role regarding the 

 69 Representatives from each of these programs were among the respondents. Descriptions of these programs are 

available at the following locations. Campus Compact is “a coalition of University presidents committed to 

promoting service learning opportunities on campus.” The website is at http://www.compact.org/. AmeriCorps 

operates two programs that place individuals in community service positions, pay a stipend, and upon completion of 

the program, a college scholarship. The website is at http://www.americorps.gov/. The Federal Work-Study 

Program provides federally subsidized employment opportunities for income-eligible students. To meet program 

requirements, at least seven percent of the work-study students at a given institution should be employed in 

community service positions, although not all universities are able to achieve this level. More information is 

available at http://www2.ed.gov/programs/fws/index.html. All URLs were last accessed on June 10, 2011.
80

assessment of an individual’s tax liability – a role that the respondents felt should belong to the 

IRS alone. These respondents generally distinguished information reporting, as on the current 

Form 1098-T, from assessments of whether a student’s experience met credit requirements. In 

general, the respondents presented few complaints about existing information reporting 

(although many stressed that it was time-consuming and burdensome), but worried about being 

asked to take on a more normative role that would include determining which volunteer 

placements qualified, tracking student attendance, and then later verifying that service was 

completed. Respondents also expressed concern that administration of the credits by the 

universities would ultimately lead to the exclusion of legitimate volunteer opportunities from 

credit eligibility because these opportunities were outside the university’s awareness. 

University Administration would be Expensive and Unfunded. Second, the respondents objected 

to the expense – they viewed the requirement as an unfunded mandate and argued that the bulk 

of the additional responsibilities would fall heaviest on offices that have recently faced staffing 

cuts. Many suggested that the requirement, if administered by the schools, could lead to 

increased fees and tuition. Respondents from university registrar and financial aid offices 

described current staffing shortages and the long list of existing responsibilities. Some of the 

respondents representing small institutions noted that their “office of financial aid” is generally 

one person with limited experience. These respondents questioned if their institutions would be 

able to do a sufficiently good job administering this credit and were concerned that their 

limitations would harm their students. 

Alternatives to University Administration. Very few respondents suggested alternatives to 

university-based administration. In general, these respondents saw a qualitative difference 

between tax-based aid and university- or Department of Education-based aid. Most of these 

respondents suggested that since the volunteer requirement was tax-based, information should be 

reported directly by the taxpayer, perhaps in conjunction with information reporting by the 

charitable organizations. 
81

Question 3 – Main Operational and Administrative Challenges.

Challenges to the Universities. As described by the respondents, one of the main challenges to

the successful implementation of a meaningful community service opportunity would be 

ensuring that sufficient opportunities exist, and that there was a reasonable match between these 

opportunities and the needs and limitations of the credit-eligible students. Respondents who 

addressed this issue did not believe that there would be sufficient opportunities in all 

communities for all students who would be potentially eligible to receive a credit and wanted to 

volunteer. As an example, they highlighted the difficulties that some institutions have meeting 

existing service requirements for the Federal Work-Study Program (Title IV).70 At least two 

responses were submitted on behalf of institutions that do not participate in Title IV – these 

respondents suggested that their institutions might have even fewer connections to the local nonprofit community than participating institutions. To highlight the expected problem with finding 

opportunities, one respondent cited the statistic that the number of students who would 

potentially be eligible for an education credit is bigger by an order of magnitude than those 

participating in “work-study”.

As reported above, many respondents stated that limited opportunity would be a particular 

challenge to students at rural institutions, although this is where many academic institutions are 

located. Local charities in these areas would not have the infrastructure to provide opportunities 

to the large population of students, and existing community need might not correspond with 

student availability. Respondents from the service learning community gave examples of 

challenges faced by their programs with developing and maintaining relationships with local 

charities. In particular, one respondent described a program that pulled back from its original 

goals because the relationships could not be sustained. 

 70 3,400 institutions participate in the Federal Work-Study program (Title IV). This program provides funds to help 

support students with financial need through part-time employment. As a requirement of the program, at least seven 

percent of the funds must go to students engaged in community service positions off campus, and at least one 

student must be employed as a reading tutor. Institutions that find it difficult to achieve the seven percent level may 

apply for a waiver. Small and rural institutions are most likely to find it onerous to achieve the seven percent 

requirement.
82

Respondents agreed that it would be important to ensure that only students who fulfill the 

requirements should receive the credit. Respondents were less sure that the institutions they 

represent would have the resources to do this. For example, the respondents expected that 

financial aid offices would have the responsibility for administering the credit. This office 

typically has limited resources, and no history of doing anything like this. Some suggested that 

charities might feel pressured, as might the schools, to sign off that community service was 

completed without proper documentation, particularly if the volunteers came from the 

communities benefitting from the service.

Other respondents focused on the word "meaningful." All agreed, perhaps tautologically, that 

the requirement must be meaningful, but the definitions of meaningful ranged from a “few hours 

self-reported” to multiple hours per year across the term. Respondents foresaw challenges in 

choosing the appropriate obligation, but were unsure how to evaluate what the appropriate metric 

would be for measuring meaningful participation, particularly if the obligation varied with 

expected credit size. Hours were considered an imperfect measure, and auditing of the charities

would clearly be administratively burdensome. Respondents were not comfortable with being 

the arbiter of “meaningful” and suggested there would be a lack of consensus.

Campuses have four pieces of infrastructure identified as being helpful in administrating the 

requirements: three existing programs (the Federal Work-Study Program, AmeriCorps and 

campus service learning programs), and financial aid offices. Respondents suggested that it 

would be challenging to expand the programs, as might be required if a volunteer obligation was 

imposed. Particularly in the case of service learning, the volunteer programs are small, intense, 

and not easily expandable. Respondents questioned if programs could survive massive growth 

or, if the programs ran in parallel, if the volunteer opportunities cultivated by service learning 

offices for their programs and courses would go to “credit students,” thus crowding out the 

opportunities for their clientele. In a world of limited opportunities, respondents questioned how 

one would choose among students for participation. Would these programs survive an influx of 

the less-committed? Respondents expressed concern that this requirement would undermine 

their hard work that created service learning programs. Respondents feared that competition for 
83

a limited number of spots, the influx of the less-committed, and being asked to potentially rank 

students based on need would undermine the well-documented successes of service learning.

Reporting Challenges to the Universities: Institutions felt that they could do a “check the box” 

along the lines of the existing 1098-T, but were unenthusiastic about accepting responsibility for 

making sure that this box did more than report that the “student waved a form at us from some 

charity.” 

Question 4 - Challenges to students.

One approach to matching students to volunteer opportunities would be to rely on the students to 

conduct the match. Many responding universities questioned whether some students could find 

sufficient legitimate opportunities on their own. A few pointed out that it would be challenging 

for some to identify opportunities because of their youth and naïveté. Others noted the challenge 

when there are not enough volunteer opportunities around. The university respondents thought 

that this approach would be less challenging than university administration, but completing the 

requirement would be less attainable for some students than it would be if there were more 

oversight.

Other respondents pointed out that the requirement would be far easier to fulfill for traditional 

students and middle class students. They reminded Treasury that the non-traditional students, 

who make up the majority at some institutions, tend to have fewer resources and greater family 

responsibilities. They would have very little room in their busy schedules for a requirement that 

would not have a positive effect on their job or their performance at school. One respondent 

suggested that very few would choose the credit over paid work, which would result in “money 

left on the table.” Some students would struggle to get to their community service assignments 

due to limits in public transportation, and other obligations during normal business hours. For 

example, students with lab work, or student teaching obligations could only do community 

service during hours where service is less likely to be needed. Respondents provided several 

anecdotes about students who work long hours. 
84

Parent/Child Relationship: A few respondents focused on the parent/child relationship and 

stressed that the obligation to perform the community service falls on students, even though it is 

the parents receiving the tax benefits. (This is the case when the student is a dependent on the 

parent’s return.) These respondents expressed concern that students might not treat the 

requirements for receipt of the credit seriously or follow through on their commitments, thus 

leaving their parents unable to claim the credit. One gave the example of first year students 

struggling to acclimate to college life who might not “get it together” in time, thus leaving their 

parents without access to the credit. Another respondent thought that this obligation would create 

“unnecessary stress” between parents and children as parents work to make sure the service is 

performed and that their children provide them the necessary documentation. This respondent 

also suggested that the students’ Thirteenth Amendment rights may be violated by a program 

where the person forced to provide the service (perhaps involuntarily) is likely different from the 

benefiting taxpayer. In summary, all respondents addressing the parent/child relationship 

thought that “burdening” parents in this way was unfair. No respondent who commented on the 

family relationship viewed the joint obligation as appropriate.

D. Conclusion

This section has explored the feasibility of creating a volunteer requirement for receipt of the 

AOTC. The analysis shows that although it might be possible to implement such a requirement, 

it could not be done in a manner consistent with good tax policy. The requirement would be 

expensive to both education institutions and the IRS to administer, would contribute to taxpayer 

compliance burden, could burden the volunteer sector, and could decrease participation rates in 

existing tax-based education programs.

XII Conclusion

Most of the Federal support for individuals pursuing higher education is available through two 

government agencies: the Department of Education, which is responsible for a number of 

federally supported direct grants and student loans, and the Department of the Treasury, which is 
85

responsible for the tax provisions administered by the Internal Revenue Service. The foundation 

of the Department of Education’s student aid programs is the Pell Grant. Pell Grants are needbased grants to assist individuals from low- and moderate-income households with their 

undergraduate education expenses. For the 2012 academic year, the maximum Pell grant is 

$5,550. The main tax benefit for undergraduates is the American Opportunity tax credit 

(AOTC). The AOTC is a partially refundable credit that provides up to $2,500 in support to 

families with expenses for tuition and fees earning less than $90,000 ($180,000 for those filing 

joint returns). The ARRA fully funded an increase in the maximum Pell Grant to $5,550 in 

2010, and created the AOTC as a substitute for the Hope credit (and to some extent the lifetime 

learning credit), which was worth a maximum of $1,800 ($2,000 for the lifetime learning credit). 

In 2009, 8.98 million tax returns claimed $15.8 billion in American Opportunity Tax Credits for 

an average tax credit of about $1,760. In addition, during FY2010 an estimated 8.9 million 

students received $36.5 billion in Pell Grant Awards for an average award of $4,115. 

Although many additional benefits exist to assist families with education expenses, this report 

focuses on the ARRA and the Pell Grants. This report examines some of the issues surrounding 

the coordination of these benefits and explores some of the ways that the delivery of these 

benefits could be improved so that more students could receive the maximum amount of aid to 

which they were entitled and in a manner that improved their ability to make good decisions 

about pursuing additional education. The report presents an analysis of the way these two 

benefits interact, sometimes supplementing each other, but sometimes at least partially offsetting 

each other. As shown in the report, Pell Grants are targeted at low-income and modest income 

families; in contrast, tax credits are more effective at targeting benefits to those with positive tax 

liability. The report also examined the feasibility of adding a volunteer requirement to the 

AOTC. 

The report presents four options for improving the coordination of the benefits:

• Further simplification of the Pell Grant and the elimination of asset information from the 

determination of Pell Grant amounts. This would create simplification without having 
86

large effects on the distribution of benefits. The majority of families receiving Pell grants 

have few major assets outside of their homes and retirement plans, which are already 

excluded in determining eligibility.

• Improve the ability of taxpayers to predict future education tax credit eligibility through 

the creation of calculators on the Department of Education Web site. The calculators 

could predict the likely value of any education tax credit for which the individual was 

eligible. This would increase the accuracy of taxpayer expectations, increase the 

visibility of the education credits to eligible individuals who may not be applying, and 

thus, lead individuals to make more informed decisions about enrollment and education 

financing.

• Improve information reporting to IRS so that taxpayers and the IRS have an accurate 

knowledge of eligible expenses. Accurate filing is challenging to students (and their 

families) and the IRS because neither receives an accurate set of information about the 

actual level of expenses which are eligible for a credit, and little guidance is provided on 

how to file once the accurate level of expenses is determined. Improving the quality of 

the third party information, first by providing accurate detail on amounts received by 

schools, and not just amounts billed, and second, by providing expense information about 

room and board separately from expense information on the credits, would improve 

compliance by taxpayers wishing to be compliant, and provide IRS with a greater ability 

to provide effective oversight. Although improved reporting would increase the demands 

on schools and universities, this burden may be appropriate given the size of the amounts 

received.

• Exclude all Pell grants from income for tax purposes, including funds used to pay for 

room and board. Including the portion of grant amounts used for room and board is 

complicated, particularly for low-income taxpayers, because of the interaction of the 

inclusion with other income-based benefits like the EITC and the AOTC itself. 

Treatment of all other scholarship income would be unchanged. This proposal would 

provide simplicity at the cost of foregone revenue.
87

Treasury examined advance refundability of the education tax credits and concludes that this 

would be challenging, expensive, and less efficient than direct student aid. The report finds that 

the limited advantages of advance refundability are outweighed by the disadvantages. The report 

concludes that direct grant aid, such as the Pell Grant, is a better mechanism for delivering 

education subsidies to low-income students.

This report also considers the feasibility of a volunteer service requirement embedded in the 

education tax credit. Such a requirement would be at odds with the general focus on 

simplification proposed here. As presented in the analysis, a requirement of this nature would 

not represent good tax policy. Technically, it could be accomplished. However, it is likely that 

the requirement would be impossible to implement in a way that was fair, consistent with the 

goals of the credit, and for which reasonable levels of compliance could be maintained.
88

Appendix: Statutory Language

Section 1004(f) of the American Recovery and Reinvestment Act of 2009, Treasury Studies 

Regarding Education Incentives:

(1) The Secretary of the Treasury and the Secretary of Education, or their delegates, shall--

(A) study how to coordinate the credit allowed under section 25A of the Internal Revenue 

Code of 1986 with the Federal Pell Grant program under section 401 of the Higher 

Education Act of 1965 to maximize their effectiveness at promoting college affordability, 

and

(B) examine ways to expedite the delivery of the tax credit.

(2) The Secretary of the Treasury and the Secretary of Education, or their delegates, shall study 

the feasibility of requiring including community service as a condition of taking their tuition and 

related expenses into account under section 25A of the Internal Revenue Code of 1986.
89

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