To amend the Internal Revenue Code of 1986 to modify the tax treatment of qualified State tuition programs.

SECTION 1. MODIFICATIONS OF TAX TREATMENT OF QUALIFIED STATE TUITION 
              PROGRAMS.

    (a) Exclusion of Distributions Used for Educational Purposes.--
Subparagraph (B) of section 529(c)(3) of the Internal Revenue Code of 
1986 (relating to treatment of distributions) is amended to read as 
follows:
                    ``(B) Distributions for qualified higher education 
                expenses.--Subparagraph (A) shall not apply to any 
                distribution to the extent--
                            ``(i) the distribution is used exclusively 
                        to pay qualified higher education expenses of 
                        the distributee, or
                            ``(ii) the distribution consists of 
                        providing a benefit to the distributee which, 
                        if paid for by the distributee, would 
                        constitute payment of a qualified higher 
                        education expense.''
    (b) Qualified Higher Education Expenses to Include Room and 
Board.--Section 529(e)(3) of the Internal Revenue Code of 1986 
(defining qualified higher education expenses) is amended by adding at 
the end the following: ``Such term shall also include reasonable costs 
(as determined under the qualified State tuition program) incurred by 
the designated beneficiary for room and board while attending such 
institution.''
    (c) Additional Modifications.--
            (1) Member of family.--Paragraph (2) of section 529(e) of 
        the Internal Revenue Code of 1986 (relating to other 
        definitions and special rules) is amended to read as follows:
            ``(2) Member of family.--The term `member of family' 
        means--
                    ``(A) an individual who bears a relationship to 
                another individual which is a relationship described in 
                paragraphs (1) through (8) of section 152(a), and
                    ``(B) a spouse of any individual described in 
                subparagraph (A).''
            (2) Eligible educational institution.--Section 529(e) of 
        such Code is amended--
                    (A) in paragraph (3), by striking ``(as defined in 
                section 135(c)(3))'' and inserting ``(within the 
                meaning of paragraph (5))'', and
                    (B) by adding at the end the following:
            ``(5) Eligible educational institution.--The term `eligible 
        educational institution' means an institution--
                    ``(A) which is described in section 481 of the 
                Higher Education Act of 1965 (20 U.S.C. 1088), as in 
                effect on the date of the enactment of this paragraph, 
                and
                    ``(B) which is eligible to participate in a program 
                under title IV of such Act.''
            (3) Technical amendments.--
                    (A) Subparagraph (B) of section 529(e)(1) of such 
                Code is amended by striking ``subsection (c)(2)(C)'' 
                and inserting ``subsection (c)(3)(C)''.
                    (B) Subparagraph (C) of section 529(e)(1) of such 
                Code is amended by inserting ``(or agency or 
                instrumentality thereof)'' after ``State or local 
                government''.
                    (C) Paragraph (2) of section 1806(c) of the Small 
                Business Job Protection Act of 1996 is amended by 
                striking so much of the first sentence as follows 
                subparagraph (B)(ii) and inserting the following:
        ``then such program (as in effect on August 20, 1996) shall be 
        treated as a qualified State tuition program with respect to 
        contributions (and earnings allocable thereto) pursuant to 
        contracts entered into under such program before the first date 
        on which such program meets such requirements (determined 
        without regard to this paragraph) and the provisions of such 
        program (as so in effect) shall apply in lieu of section 529(b) 
        of the Internal Revenue Code of 1986 with respect to such 
        contributions and earnings.''
    (d) Coordination With Education Savings Bond.--Section 135(c)(2) of 
the Internal Revenue Code of 1986 (defining qualified higher education 
expenses) is amended by adding at the end the following:
                    ``(C) Contributions to qualified state tuition 
                program.--Such term shall include any contribution to a 
                qualified State tuition program (as defined in section 
                529) on behalf of a designated beneficiary (as so 
                defined) who is an individual described in subparagraph 
                (A).''
    (e) Effective Dates.--
            (1) In general.--Except as provided in paragraph (2), the 
        amendments made by this section shall apply to taxable years 
        beginning after December 31, 1996.
            (2) Additional modifications.--The amendments made by 
        subsection (c) shall take effect as if included in the 
        amendments made by, and the provisions of, section 1806 of the 
        Small Business Job Protection Act of 1996.

Summary: Amends the Internal Revenue Code, with respect to qualified State tuition programs to, among other things:  (1) provide for the exclusion from gross income of distributions used for qualified higher education expenses; (2) include room and board in the definition of qualified higher education expenses; and (3) permit income from redeemed U.S. savings bonds to be used to contribute, without including such income in gross income (subject to income limitations), to a qualified State tuition program.