for the taxable year in which the payment or dis-
tribution is received to the extent such amount is
not the return of a contribution for which no deduc-
tion was allowed under subsection (a).
‘‘(2) DISTRIBUTION USED TO PAY QUALIFIED
HIGHER
EDUCATION
EXPENSES.—Paragraph (1)
shall not apply to any payment or distribution out
of an education savings plan to the extent such pay-
ment or distribution is used exclusively to pay the
qualified higher education expenses incurred by the
individual for whose benefit the plan is established
while such individual is an eligible student (as de-
fined in section 221).
‘‘(3) DISTRIBUTIONS TO ANOTHER PLAN OR TO
INSTITUTION
OF
HIGHER
EDUCATION.—Paragraph
(1) shall not apply to any distribution under sub-
section (c)(2)(E)(ii).
‘‘(4) EXCESS CONTRIBUTIONS RETURNED BE-
FORE DUE DATE OF RETURN.—Paragraph (1) does
not apply to the distribution of any contribution paid
during a taxable year to an education savings plan
to the extent that such contribution exceeds the
amount allowable as a deduction under subsection
(a) for contributions to such plan if—
‘‘(A) such distribution is received on or be-
fore the day prescribed by law (including exten-
sions of time) for filing such individual’s return
for such taxable year,
‘‘(B) no deduction is allowed under sub-
section (a) with respect to such excess contribu-
tion, and
‘‘(C) such distribution is accompanied by
the amount of net income attributable to such
excess contribution.
Any net income described in subparagraph (C) shall
be included in the gross income of the individual for
the taxable year in which such excess contribution
was made.
‘‘(e) TAX TREATMENT OF PLANS.—
‘‘(1) EXEMPTION
FROM
TAX.—An education
savings plan is exempt from taxation under this sub-
title unless such plan has ceased to be an education
savings plan by reason of paragraph (3). Notwith-
standing the preceding sentence, any such plan is
subject to the taxes imposed by section 511 (relating
to imposition of tax on unrelated business income of
charitable, etc. organizations).
‘‘(2) AMOUNT IN PLAN NOT TO AFFECT ELIGI-
BILITY
FOR
OTHER
FEDERAL
ASSISTANCE.—
Amounts held in any education savings plan shall
not be taken into account in determining the eligi-
bility for, or the amount of, any grant under any
Federal student assistance program.
‘‘(3) LOSS OF EXEMPTION OF PLAN WHERE IN-
DIVIDUAL
ENGAGES
IN
PROHIBITED
TRANS-
ACTION.—
‘‘(A) IN GENERAL.—If the individual for
whose benefit an education savings plan is es-
tablished or any individual who contributes to
such plan engages in any transaction prohibited
by section 4975 with respect to the plan, the
plan shall cease to be an education savings plan
as of the first day of the taxable year (of the
individual so engaging in such transaction) dur-
ing which such transaction occurs.
‘‘(B) PLAN
TREATED
AS
DISTRIBUTING
ALL ITS ASSETS.—In any case in which any
plan ceases to be an education savings plan by
reason of subparagraph (A) as of the first day
of any taxable year, paragraph (1) of subsection
(d) shall apply as if there was a distribution on
such first day in an amount equal to the fair
market value (on such first day) of all assets in
the plan (on such first day).
‘‘(4) EFFECT
OF
PLEDGING
PLAN
AS
SECU-
RITY.—If, during any taxable year, the individual for
whose benefit an education savings plan is estab-
lished, or any individual who contributes to such
plan, uses the plan or any portion thereof as security
for a loan, the portion so used shall be treated as
distributed to the individual so using such portion.
‘‘(f) ADDITIONAL TAX ON CERTAIN AMOUNTS IN-
CLUDED IN GROSS INCOME.—
‘‘(1) DISTRIBUTION NOT USED FOR QUALIFIED
HIGHER EDUCATION EXPENSES.—In the case of any
payment or distribution to which subsection (d)(1)
applies, the tax liability of each payee or distributee
under this chapter for the taxable year in which the
payment or distribution is received shall be increased
by an amount equal to 10 percent of the amount of
the distribution which is includible in the gross in-
come of such payee or distributee for such taxable
year.
‘‘(2) DISQUALIFICATION CASES.—If an amount
is includible in the gross income of an individual for
a taxable year because such amount is required to
be treated as a distribution under paragraph (2) or
(3) of subsection (e), such individual’s tax liability
under this chapter for such taxable year shall be in-
creased by an amount equal to 10 percent of such
amount required to be treated as a distribution and
included in his gross income.
‘‘(3) DISABILITY
OR
DEATH
CASES.—Para-
graphs (1) and (2) shall not apply if the payment
or distribution is made after the individual for whose
benefit the education savings plan becomes disabled
within the meaning of section 72(m)(7) or dies.
‘‘(g) COMMUNITY PROPERTY LAWS.—This section
shall be applied without regard to any community property
laws.
‘‘(h) CUSTODIAL PLANS.—For purposes of this sec-
tion, a custodial plan shall be treated as a trust if the
assets of such plan are held by a bank (as defined in sec-
tion 408(n)) or another person who demonstrates, to the
satisfaction of the Secretary, that the manner in which
he will administer the plan will be consistent with the re-
quirements of this section, and if the custodial plan would,
except for the fact that it is not a trust, constitute an
education savings plan described in subsection (c)(2). For
purposes of this title, in the case of a custodial plan treat-
ed as a trust by reason of the preceding sentence, the cus-
todian of such plan shall be treated as the trustee thereof.
‘‘(i) REPORTS.—The trustee of an education savings
plan shall make such reports regarding such plan to the
Secretary and to the individual for whose benefit the plan
is maintained with respect to contributions, distributions,
and such other matters as the Secretary may require
under regulations. The reports required by this subsection
shall be filed at such time and in such manner and fur-
nished to such individuals at such time and in such man-
ner as may be required by those regulations.’’
(b) DEDUCTION ALLOWED
IN ARRIVING
AT AD-
JUSTED GROSS INCOME.—Paragraph (7) of section 62(a)
of such Code (relating to retirement savings) is amend-
ed—
(1) by inserting ‘‘OR EDUCATION’’ after ‘‘RE-
TIREMENT’’ in the heading of such paragraph, and
(2) by inserting before the period at the end the
following: ‘‘and the deduction allowed by section 222
(relating to education savings plans)’’.
(c) TAX ON EXCESS CONTRIBUTIONS.—Section 4973
of such Code (relating to tax on excess contributions to
individual retirement plans, certain section 403(b) con-
tracts, and certain individual retirement annuities) is
amended—
(1) by inserting ‘‘EDUCATION SAVINGS PLANS,’’
after ‘‘MEDICAL SAVINGS ACCOUNTS,’’ in the heading
of such section,
(2) by striking ‘‘or’’ at the end of paragraph
(2) of subsection (a),
(3) by redesignating paragraph (3) of sub-
section (a) as paragraph (4) and by inserting after
paragraph (2) the following new paragraph:
‘‘(3) an education savings plan (within the
meaning of section 222(c)(2)), or’’, and
(4) by adding at the end the following new sub-
section:
‘‘(e) EXCESS CONTRIBUTIONS TO EDUCATION SAV-
INGS PLANS.—For purposes of this section, in the case
of an education savings plan, the term ‘excess contribu-
tions’ means the amount by which the amount contributed
for the taxable year to the plan exceeds the amount allow-
able as a deduction under section 222 for such taxable
year. For purposes of this subsection, any contribution
which is distributed out of the education savings plan in
a distribution to which section 222(d)(4) applies shall be
treated as an amount not contributed.’’
(d) CONTRIBUTION NOT SUBJECT TO GIFT TAX.—
Section 2503 of such Code (relating to taxable gifts) is
amended by adding at the end the following new sub-
section:
‘‘(h) EDUCATION SAVINGS PLANS.—Any contribution
made by an individual to an education savings plan de-
scribed in section 222(c)(2) which is allowable as a deduc-
tion under section 222 shall not be treated as a transfer
of property by gift for purposes of this chapter.’’
(e) TAX ON PROHIBITED TRANSACTIONS.—
(1) Section 4975 of such Code (relating to pro-
hibited transactions) is amended by adding at the
end of subsection (c) the following new paragraph:
‘‘(5) SPECIAL RULE FOR EDUCATION SAVINGS
PLANS.—An individual for whose benefit an edu-
cation savings plan is established and any contribu-
tor to such plan shall be exempt from the tax im-
posed by this section with respect to any transaction
concerning such plan (which would otherwise be tax-
able under this section) if, with respect to such
transaction, the plan ceases to be an education sav-
ings plan by reason of the application of section
222(e)(2)(A) to such plan.’’
(2) Paragraph (1) of section 4975(e) is amend-
ed by striking ‘‘or’’ at the end of subparagraph (D),
by redesignating subparagraph (E) as subparagraph
(F), and by inserting after subparagraph (D) the
following new subparagraph:
‘‘(E) an education savings plan described
in section 222(c)(2), or’’.
(f) FAILURE TO PROVIDE REPORTS ON EDUCATION
SAVINGS PLANS.—
(1) Paragraph (2) of section 6693(a) of such
Code (relating to failure to provide reports on indi-
vidual retirement plans or annuities) is amended by
striking ‘‘and’’ at the end of subparagraph (A), by
striking the period at the end of subparagraph (B)
and inserting ‘‘, and’’, and by adding at the end the
following new subparagraph:
‘‘(C) section 222(i) (relating to education
savings plans).’’
(2) The section heading for section 6693 of
such Code is amended by inserting ‘‘or on education
savings plans’’ after ‘‘annuities’’.
(g) SPECIAL RULE FOR DETERMINING AMOUNTS OF
SUPPORT FOR DEPENDENT.—Subsection (b) of section
152 of such Code (relating to definition of dependent) is
amended by adding at the end the following new para-
graph:
‘‘(6) A distribution from an education savings
plan described in section 222(c)(2) to the individual
for whose benefit such plan has been established
shall not be taken into plan in determining support
for purposes of this section to the extent such dis-
tribution is excluded from gross income of such indi-
vidual under section 222(d)(2).’’
(h) CLERICAL AMENDMENTS.—
(1) The table of sections for part VII of sub-
chapter B of chapter 1 of such Code is amended by
striking the item relating to section 222 and insert-
ing the following new items:
‘‘Sec. 222. Education savings plans.
‘‘Sec. 223. Cross references.’’
(2) The table of sections for chapter 43 of such
Code is amended by striking the item relating to sec-
tion 4973 and inserting the following new item:
‘‘Sec. 4973. Tax on excess contributions to individual retirement
accounts, medical savings accounts, education sav-
ings plans, certain 403(b) contracts, and certain in-
dividual retirement annuities.’’
(3) The table of sections for subchapter B of
chapter 68 of such Code is amended by striking the
item relating to section 6693 and inserting the fol-
lowing new item:
‘‘Sec. 6693. Failure to provide reports on individual retirement
accounts or annuities or on education savings
plans.’’
(i) EFFECTIVE DATE.—The amendments made by
this section shall apply to contributions made in taxable
years beginning after December 31, 1996.
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