NASFAA, along with several higher education organizations, signed on to a letter by the American Council on Education (ACE) urging leaders of the House Ways and Means Committee and the Senate Finance Committee to include the Tax-Free Pell Grant Act in any lame-duck tax legislation.
The letter, addressed to Sens. Ron Wyden (D-Ore.) and Mike Crapo (R-Idaho) and Reps. Richard Neal (D-Mass.) and Kevin Brady (R-Texas), calls on the lawmakers to incorporate the Tax-Free Pell Grant Act in any lame-duck tax package in order to better coordinate Pell Grants with the American Opportunity Tax Credit (AOTC).
The letter notes students who receive Pell Grants may qualify for the AOTC, a tax credit of up to $2,500 available to students during their first four years of postsecondary education to offset costs for qualified education expenses. But many fail to claim the tax credit because of the "complicated way" it interacts with the tax treatment of Pell Grants. AOTC rules require that applicants subtract their Pell Grant from eligible expenses on their 1098-T form when filing their taxes due to a grant/scholarship offset provision, reducing or eliminating their AOTC eligibility.
Affected Pell recipients could still claim the AOTC by using their Pell Grant to cover non-tuition expenses like room and board, but then that portion of their Pell Grant would be taxable per Internal Revenue Service (IRS) rules. The IRS states the process for claiming education-related tax credits, including the AOTC, results in many eligible students and parents foregoing tax credits for which they qualify. The complexity of claiming these credits affects almost 9 million students who receive Pell Grants and results in hundreds of millions of dollars of unclaimed credits each year.
The letter notes that maximizing the AOTC requires a "complicated calculation" to determine how much of a student's Pell Grant to include in taxable income before the additional tax liability exceeds the amount of AOTC for which the student qualifies. This issue only impacts students whose tuition and related expenses after accounting for scholarships are less than $4,000. According to data from the Department of Education, approximately 730,000 Pell Grant students are affected by this issue each academic year.
Pell Grants used on non-tuition expenses like room and board have been taxed as a form of
unearned income since 1986. However, the letter argues that repealing the taxability of Pell Grants would permit low-income students to claim more financial aid while helping to simplify the tax code. NASFAA and other higher education organizations have previously advocated to repeal the taxability of Pell Grants.
Because the costs of non-tuition higher education expenses — like housing, food and transportation — have risen, approximately 3 million students receive aid that is subject to taxation, according to the letter. And according to the College Board, in the 2021-22 academic year, taxable higher education expenses — such as room and board, transportation, and other expenses — made up 72% of undergraduate students' budget at two-year institutions, 56% for four-year public institutions, and 29.5% for private, four-year nonprofit institutions.
The letter notes there have been bipartisan efforts to address this issue for years, including with the Obama administration, which sought to address this issue in its fiscal year 2015 and 2016 Budget Revenue Proposals. Additionally, the bipartisan Student and Family Tax Simplification Act sponsored by former Rep. Diane Black (R-Tenn.), included provisions to fix the taxability of Pell Grants.
In this congressional session, ACE has endorsed the House's "Tax-Free Pell Grant Act" sponsored by Rep. Lloyd Doggett (D-Texas) and the Senate's "Tax-Free Pell Grant Act" sponsored by Sen. Sheldon Whitehouse (D-R.I.).
"Fixing the AOTC-Pell interaction issue by repealing the taxability of Pell Grants and the AOTC Pell offset advances efforts to simplify the tax code by ensuring low-income students access a tax benefit they qualify for and which many of their peers are utilizing, and makes it easier for these students to navigate their tax obligations," the letter states. "We strongly urge Congress to repeal the taxability of Pell Grants by incorporating the "TaxFree Pell Grant Act" in any lame-duck tax package."
Publication Date: 11/1/2022