II

104TH CONGRESS

1ST SESSION S. 386

To amend the Internal Revenue Code of 1986 to provide for the tax-free

treatment of education savings accounts established through certain State

programs, and for other purposes.

IN THE SENATE OF THE UNITED STATES

FEBRUARY 10 (legislative day, JANUARY 30), 1995

Mr. MCCONNELL introduced the following bill; which was read twice and

referred to the Committee on Finance

A BILL

To amend the Internal Revenue Code of 1986 to provide

for the tax-free treatment of education savings accounts

established through certain State programs, and for

other purposes.

1 Be it enacted by the Senate and House of Representa2 tives of the United States of America in Congress assembled,

3 SECTION 1. TAX TREATMENT OF STATE EDUCATION SAV4 INGS ACCOUNTS.

5 (a) IN GENERAL.—Part III of subchapter B of chap6 ter 1 of the Internal Revenue Code of 1986 (relating to

7 items specifically excluded from gross income) is amended
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1 by redesignating section 137 as section 138 and by adding

2 after section 136 the following new section:

3 ‘‘SEC. 137. EDUCATION SAVINGS ACCOUNTS.

4 ‘‘(a) GENERAL RULE.—Gross income shall not in5 clude any qualified education savings account distribution.

6 ‘‘(b) QUALIFIED EDUCATION SAVINGS ACCOUNT

7 DISTRIBUTION.—For purposes of this section—

8 ‘‘(1) IN GENERAL.—The term ‘qualified edu9 cation savings account distribution’ means any

10 amount paid or distributed out of an education sav11 ings account which would otherwise be includible in

12 gross income to the extent such payment or distribu13 tion is used exclusively to pay qualified higher edu14 cation expenses incurred by the designated bene15 ficiary of the account.

16 ‘‘(2) ROLLOVERS.—The term ‘qualified edu17 cation savings account distribution’ includes any

18 transfer from an education savings account of one

19 designated beneficiary to another such account of

20 such beneficiary or to such an account of another

21 designated beneficiary.

22 ‘‘(3) SPECIAL RULES.—The determination

23 under paragraph (1) as to whether an amount is

24 otherwise includible in gross income shall be made in

25 the manner described in section 72, except that—
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1 ‘‘(A) all education savings accounts shall

2 be treated as one contract,

3 ‘‘(B) all distributions during any taxable

4 year shall be treated as one distribution,

5 ‘‘(C) contributions to an account described

6 in subsection (c)(4)(B)(i) shall not be included

7 in the investment in the contract with respect

8 to the account, and

9 ‘‘(D) the value of the contract, income on

10 the contract, and investment in the contract

11 shall be computed as of the close of the cal12 endar year in which the taxable year begins.

13 ‘‘(c) EDUCATION SAVINGS ACCOUNT.—For purposes

14 of this section—

15 ‘‘(1) IN GENERAL.—The term ‘education sav16 ings account’ means a trust created or organized in

17 the United States—

18 ‘‘(A) pursuant to a qualified State edu19 cational savings plan, and

20 ‘‘(B) exclusively for the purpose of paying

21 the qualified higher education expenses of the

22 designated beneficiary of the account.

23 ‘‘(2) QUALIFIED STATE EDUCATIONAL SAVINGS

24 PLAN.—The term ‘qualified State educational sav-
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1 ings plan’ means a plan established and maintained

2 by a State or instrumentality thereof under which—

3 ‘‘(A) participants may save to meet quali4 fied higher education expenses of designated

5 beneficiaries,

6 ‘‘(B) planning and financial information is

7 provided to participants about current and pro8 jected qualified higher education expenses,

9 ‘‘(C) education savings account statements

10 are provided to participants at least quarterly,

11 and

12 ‘‘(D) an audited financial statement is pro13 vided to participants at least annually.

14 ‘‘(3) QUALIFIED HIGHER EDUCATION EX15 PENSES.—The term ‘qualified higher education ex16 penses’ means the cost of attendance (as defined in

17 section 472 of the Higher Education Act of 1965).

18 ‘‘(4) LIMITATIONS.—A trust shall not be treat19 ed as an education savings account unless the follow20 ing requirements are met:

21 ‘‘(A) No contribution will be accepted un22 less it is in cash, stocks, bonds, or other securi23 ties which are readily tradable on an established

24 securities market.
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1 ‘‘(B) Contributions will not be accepted for

2 any taxable year in excess of the applicable

3 limit. The preceding sentence shall not apply

4 to—

5 ‘‘(i) contributions to the qualified

6 State educational savings plan which are

7 allocated to all education savings accounts

8 within the class for which the contribution

9 was made, or

10 ‘‘(ii) rollover contributions described

11 in subsection (b)(2).

12 ‘‘(C) The trust may not be established for

13 the benefit of more than one individual.

14 ‘‘(D) The trustee is the qualified State

15 educational savings plan or person designated

16 by it.

17 ‘‘(E) The assets of the trust may be in18 vested only in accordance with the qualified

19 State educational savings plan.

20 ‘‘(5) APPLICABLE LIMIT.—For purposes of

21 paragraph (4)(B)—

22 ‘‘(A) IN GENERAL.—The applicable limit is

23 $3,000.

24 ‘‘(B) INDEXING.—In the case of taxable

25 years beginning after December 31, 1995, the
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1 $3,000 amount under subparagraph (A) shall

2 be increased by the education cost-of-living ad3 justment for the calendar year in which the tax4 able year begins.

5 ‘‘(C) EDUCATION COST-OF-LIVING ADJUST6 MENT.—For purposes of subparagraph (B), the

7 education cost-of-living adjustment for any cal8 endar year is the percentage (if any) by

9 which—

10 ‘‘(i) the higher education cost index

11 for the preceding calendar year, exceeds

12 ‘‘(ii) such index for 1994.

13 ‘‘(D) HIGHER EDUCATION COST INDEX.—

14 For purposes of subparagraph (C), the higher

15 education cost index for any calendar year is

16 the average qualified higher education expenses

17 for undergraduate students at both private and

18 public institutions of higher education for the

19 12-month period ending on August 31 of the

20 calendar year. The Secretary of Education shall

21 provide for the computation and publication of

22 the higher education cost index.

23 ‘‘(d) TAX TREATMENT OF ACCOUNTS AND STATE

24 PLANS.—
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1 ‘‘(1) EXEMPTION FROM TAX.—An education

2 savings account shall be exempt from taxation under

3 this subtitle. Notwithstanding the preceding sen4 tence, any such account or plan shall be subject to

5 the taxes imposed by section 511 (relating to imposi6 tion of tax on unrelated business income of chari7 table, etc. organizations).

8 ‘‘(2) LOSS OF EXEMPTION OF ACCOUNT WHERE

9 INDIVIDUAL ENGAGES IN PROHIBITED TRANS10 ACTION.—

11 ‘‘(A) IN GENERAL.—If the designated ben12 eficiary of an education savings account is es13 tablished or any individual who contributes to

14 such account engages in any transaction prohib15 ited by section 4975 with respect to the ac16 count, the account shall cease to be an edu17 cation savings account as of the first day of the

18 taxable year (of the individual so engaging in

19 such transaction) during which such transaction

20 occurs.

21 ‘‘(B) ACCOUNT TREATED AS DISTRIBUTING

22 ALL ITS ASSETS.—In any case in which any ac23 count ceases to be an education savings account

24 by reason of subparagraph (A) as of the first

25 day of any taxable year, an amount equal to the
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1 fair market value of all assets in the account

2 shall be treated as having been distributed on

3 such first day.

4 ‘‘(3) EFFECT OF PLEDGING ACCOUNT AS SECU5 RITY.—If, during any taxable year, the individual for

6 whose benefit an education savings account is estab7 lished, or any individual who contributes to such ac8 count, uses the account or any portion thereof as se9 curity for a loan, the portion so used shall be treated

10 as distributed to the individual so using such por11 tion.

12 ‘‘(e) REPORTS.—The Secretary may require the

13 trustee of an education savings account to make reports

14 regarding such account to the Secretary, to the individual

15 who has established the account, and to the designated

16 beneficiary of the account with respect to contributions,

17 distributions, and such other matters as the Secretary

18 may require. The reports required by this subsection shall

19 be filed at such time and in such manner and furnished

20 to such individuals at such time and in such manner as

21 may be required by those regulations.’’

22 (b) TAX TREATMENT OF QUALIFIED STATE EDU23 CATIONAL SAVINGS PLAN.—

24 (1) TREATMENT AS SECTION 501(c)(3) ORGANI25 ZATION.—Section 501(c)(3) of such Code is amend-
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1 ed by inserting ‘‘or which is a qualified State edu2 cational savings plan (as defined in section

3 137(c)(2)),’’ after ‘‘animals,’’.

4 (2) CHARITABLE CONTRIBUTIONS.—

5 (A) Subparagraph (B) of section 170(c)(2)

6 of such Code is amended by inserting ‘‘, or

7 which is a qualified State educational savings

8 plan (as defined in section 137(c)(2)),’’ after

9 ‘‘animals’’.

10 (B) Section 170(b)(1)(A) of such Code is

11 amended by striking ‘‘or’’ at the end of clause

12 (vii), by inserting ‘‘or’’ at the end of clause

13 (viii) and by inserting after clause (viii) the fol14 lowing new clause:

15 ‘‘(ix) a qualified State educational

16 savings plan (as defined in section

17 137(c)(2)).’’

18 (c) CONTRIBUTION NOT SUBJECT TO GIFT TAX.—

19 Section 2503 of such Code (relating to taxable gifts) is

20 amended by adding at the end the following new sub21 section:

22 ‘‘(h) EDUCATION SAVINGS ACCOUNTS.—Any con23 tribution made by an individual to an education savings

24 account described in section 137 shall not be treated as
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1 a transfer of property by gift for purposes of this chap2 ter.’’

3 (d) TAX ON PROHIBITED TRANSACTIONS.—Section

4 4975 of such Code (relating to prohibited transactions)

5 is amended—

6 (1) by adding at the end of subsection (c) the

7 following new paragraph:

8 ‘‘(4) SPECIAL RULE FOR EDUCATION SAVINGS

9 ACCOUNTS.—An individual for whose benefit an edu10 cation savings account is established and any con11 tributor to such account shall be exempt from the

12 tax imposed by this section with respect to any

13 transaction concerning such account (which would

14 otherwise be taxable under this section) if, with re15 spect to such transaction, the account ceases to be

16 an education savings account by reason of the appli17 cation of section 137(d)(2)(A) to such account.’’,

18 and

19 (2) by inserting ‘‘, an education savings account

20 described in section 137(c),’’ in subsection (e)(1)

21 after ‘‘described in section 408(a)’’.

22 (e) FAILURE TO PROVIDE REPORTS ON EDUCATION

23 SAVINGS ACCOUNTS.—Section 6693 of such Code (relat24 ing to failure to provide reports on individual retirement

25 accounts or annuities) is amended—
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1 (1) by inserting ‘‘OR ON EDUCATION SAV2 INGS ACCOUNTS’’ after ‘‘ANNUITIES’’ in the

3 heading of such section, and

4 (2) by adding at the end of subsection (a) the

5 following new sentence: ‘‘Any person required by

6 section 137(e) to file a report regarding an edu7 cation savings account who fails to file the report at

8 the time or in the manner required by such section

9 shall pay a penalty of $50 for each failure, unless

10 it is shown that such failure is due to reasonable

11 cause.’’

12 (f) SPECIAL RULE FOR DETERMINING AMOUNTS OF

13 SUPPORT FOR DEPENDENT.—Subsection (b) of section

14 152 of such Code (relating to definition of dependent) is

15 amended by redesignating paragraph (6) as paragraph (7)

16 and by inserting after paragraph (5) the following new

17 paragraph:

18 ‘‘(6) A distribution from an education savings

19 account described in section 137(c) to the individual

20 for whose benefit such account has been established

21 shall not be taken into account in determining sup22 port for purposes of this section to the extent such

23 distribution is excluded from gross income of such

24 individual under section 137.’’

25 (g) CLERICAL AMENDMENTS.—
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1 (1) The table of sections for part III of sub2 chapter B of chapter 1 of such Code is amended by

3 striking out the item relating to section 137 and in4 serting the following new items:

‘‘Sec. 137. Education savings accounts.

‘‘Sec. 138. Cross references to other Acts.’’

5 (2) The table of sections for subchapter B of

6 chapter 68 of such Code is amended by striking out

7 the item relating to section 6693 and inserting the

8 following new item:

‘‘Sec. 6693. Failure to provide reports on individual retirement

accounts or annuities or on education savings accounts.’’

9 (h) EFFECTIVE DATE.—The amendments made by

10 this section shall apply to contributions made in taxable

11 years beginning after December 31, 1994.

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