Federal Student Aid - IFAP
   
PublicationDate: 11/1/97
Author: IRS
Summary: Education Tax Incentives


Part III - Administrative, Procedural, and Miscellaneous


Education Tax Incentives


Notice 97-60

PURPOSE

The questions and answers contained in this notice provide guidance
on the higher education tax incentives recently enacted by the
Taxpayer Relief Act of 1997 (Pub. L. No. 105-34, 111 Stat. 788)
(TRA '97). Specifically, TRA '97 added § 25A of the Internal
Revenue Code providing the Hope Scholarship Credit and Lifetime
Learning Credit, § 221 providing a deduction for student loan
interest, and § 530 creating Education Individual Retirement
Accounts ("Education IRAs"). TRA '97 also amended § 72(t)
eliminating the early withdrawal tax on certain IRA withdrawals, §
127 providing an exclusion from income for employer-provided
educational assistance, and § 529 setting the requirements for tax-
exempt status for qualified state tuition programs (QSTPs).

These provisions create several new tax benefits for families who are
saving for, or already paying, higher education costs or are repaying
student loans. In addition, TRA '97 extends the exclusion for
employer-provided educational assistance and makes the rules for
qualified state tuition programs more flexible. The following
discussion reviews in greater detail the requirements for each of
these benefits. Whether a taxpayer may take advantage of these
benefits depends on the taxpayer's individual facts and
circumstances.

DISCUSSION


SECTION 1. THE HOPE SCHOLARSHIP CREDIT

Beginning January 1, 1998, taxpayers may be eligible to
claim a nonrefundable Hope Scholarship Credit against their
federal income taxes. The Hope Scholarship Credit may be claimed
for the qualified tuition and related expenses of EACH student in
the taxpayer's family (i.e., the taxpayer, the taxpayer's spouse,
or an eligible dependent) who is enrolled at least half-time in
one of the first two years of postsecondary education and who is
enrolled in a program leading to a degree, certificate, or other
recognized educational credential. The amount that may be
claimed as a credit is generally equal to: (1) 100 percent of
the first $1,000 of the taxpayer's out-of-pocket expenses for
each student's qualified tuition and related expenses, plus (2)
50 percent of the next $1,000 of the taxpayer's out-of-pocket
expenses for each student's qualified tuition and related
expenses. Thus, the maximum credit a taxpayer may claim for a
taxable year is $1,500 multiplied by the number of students in
the family who meet the enrollment criteria described above.

The amount a taxpayer may claim as a Hope Scholarship Credit
is gradually reduced for taxpayers who have modified adjusted
gross income between $40,000 ($80,000 for married taxpayers
filing jointly) and $50,000 ($100,000 for married taxpayers
filing jointly). Taxpayers with modified adjusted gross income
over $50,000 ($100,000 for married taxpayers filing jointly) may
not claim the Hope Scholarship Credit. Both the dollar
limitation on the expenses for which the credit may be claimed
and the modified adjusted gross income limitation will be indexed
for inflation in 2002 and years thereafter.

The Hope Scholarship Credit may be claimed for payments of
qualified tuition and related expenses made on or after January
1, 1998, for academic periods beginning on or after January 1,
1998. Therefore, the first time taxpayers will be able to claim
the credit is when they file their 1998 tax returns in 1999. The
Hope Scholarship Credit is not available for any amount paid in
1997.

Q1: Who may claim the Hope Scholarship Credit?
A1: An individual paying qualified tuition and related expenses
at a postsecondary educational institution may claim the
credit, provided the student whose expenses are being paid
and the institution meet certain eligibility requirements.
Q2: May an individual claim a Hope Scholarship Credit for paying
qualified tuition and related expenses for other family
members?
A2: Yes. An individual may claim the credit for his/her own
qualified tuition and related expenses and the qualified
tuition and related expenses of his/her spouse and other
eligible dependents (including children) for whom the
dependency exemption is claimed. Generally, a parent may
claim the dependency exemption for his/her unmarried child
if: (1) the parent supplies more than half the child's
support for the taxable year, and (2) the child is under age
19 or is a full-time student under age 24.
Q3: What are the eligibility requirements for the student?
A3: A student is eligible for the Hope Scholarship Credit if:
(1) for at least one academic period (e.g., semester,
trimester, quarter) beginning during the calendar year, the
student is enrolled at least half-time in a program leading
to a degree, certificate, or other recognized educational
credential and is enrolled in one of the first two years of
postsecondary education, and (2) the student is free of any
conviction for a Federal or State felony offense consisting
of the possession or distribution of a controlled substance.
For purposes of the Hope Scholarship Credit, a student will
be considered to be enrolled at least half-time if the
student is enrolled for at least half the full-time academic
workload for the course of study the student is pursuing as
determined under the standards of the institution where the
student is enrolled. The institution's standard for a full-time
workload must equal or exceed the standards established
by the Department of Education under the Higher Education
Act and set forth in 34 C.F.R. § 674.2(b).
Q4: What are the eligibility requirements for the institution?
A4: The college, university, vocational school, or other
postsecondary educational institution where the student is
enrolled must be an institution that is described in section
481 of the Higher Education Act of 1965 (20 U.S.C. 1088)
and, therefore, eligible to participate in the student aid
programs administered by the Department of Education. This
category includes virtually all accredited public,
nonprofit, and proprietary postsecondary institutions. (The
same eligibility requirements for institutions apply for the
Lifetime Learning Credit, described in the next section.)
Q5: The Hope Scholarship Credit may be claimed only for amounts
spent on "qualified tuition and related expenses." Which
expenses are included in qualified tuition and related
expenses?
A5: The term "qualified tuition and related expenses" means the
tuition and fees an individual is required to pay in order
to be enrolled at or attend an eligible institution.
Amounts paid for any course or other education involving
sports, games, or hobbies are not eligible for the credit,
unless the course or other education is part of the
student's degree program. Charges and fees associated with
room, board, student activities, athletics, insurance,
books, equipment, transportation, and similar personal,
living, or family expenses are not qualified tuition or
related expenses. (The same definition of "qualified
tuition and related expenses" applies for the Lifetime
Learning Credit, described in the next section.)
Q6: The Hope Scholarship Credit is available only if a
taxpayer's "modified adjusted gross income" is below a
specified amount. How does a taxpayer know what his/her
modified adjusted gross income is?
A6: For most taxpayers, modified adjusted gross income is the
same as adjusted gross income. Taxpayers compute adjusted
gross income as part of completing a Federal income tax
return. For those few taxpayers who earn income abroad or
receive income from certain American territories or
possessions, modified adjusted gross income will be greater
than adjusted gross income. In those cases, the
individual's adjusted gross income will be increased by:
(1) certain amounts that the individual earns abroad, (2)
amounts effectively connected with the individual's conduct
of a trade or business or derived from sources in Guam,
American Samoa, or the Northern Mariana Islands (if the
individual is a resident of the possession where the source
of the income is located), and (3) amounts derived from
sources in Puerto Rico (if the individual is a Puerto Rican
resident). (The same rules apply for the Lifetime Learning
Credit, described in the next section.)
Q7: May a nonresident alien claim the Hope Scholarship Credit?
A7: Generally no. There is an exception for certain nonresident
aliens who are married to U.S. citizens or resident aliens.
Nonresident aliens should consult a U.S. tax advisor to
determine whether the exception applies to them. (The same
rules apply to the Lifetime Learning Credit, described in
the next section.)
Q8: Are qualified tuition and related expenses for graduate-level
degree work eligible for the Hope Scholarship Credit?
A8: No. However, the Lifetime Learning Credit is available for
these expenses. (See Sec. 2, Q&A5.)
Q9: May an individual claim a Hope Scholarship Credit for more
than one family member?
A9: Yes. Furthermore, the credit is calculated on a per
student, rather than a per family, basis. For example, if
an individual whose modified adjusted gross income is
$35,000 pays over $2,000 in qualified tuition and related
expenses for himself and over $2,000 in qualified tuition
and related expenses for his dependent child, and both he
and his dependent child meet the eligibility requirements,
the individual may claim a Hope Scholarship Credit of $3,000
(i.e., a credit of $1,500 for his expenses plus a credit of
$1,500 for his child's expenses).
Q10: May both the parent and a dependent child claim the Hope
Scholarship Credit for the child's qualified tuition and
related expenses in the same year?
A10: No. Either the parent or the child, but not both, may claim
the credit for the child's expenses in a particular year.
If an individual claims the child as a dependent on his/her
Federal income tax return for the year, only the individual
may claim the Hope Scholarship Credit for the child's
qualified tuition and related expenses. If no one claims
the child as a dependent on a Federal income tax return for
the year, only the child may claim the Hope Scholarship
Credit for the child's expenses. (The same rules relating
to individuals and dependents apply for the Lifetime
Learning Credit, described in the next section.)
Q11: If a married taxpayer files a separate return, may the
taxpayer claim a Hope Scholarship Credit on his/her income
tax return?
A11: No. Married taxpayers may claim the credit only if the
taxpayer and the taxpayer's spouse file a joint return for
the taxable year. (The same rules apply for the Lifetime
Learning Credit, described in the next section.)
Q12: How does a parent claim a Hope Scholarship Credit for the
qualified tuition and related expenses of a dependent child?
A12: The parent may claim the credit on his/her tax return even
if the child files his/her own tax return. When a child is
claimed as a dependent on a parent's return, any qualified
tuition or related expenses paid by the child during the
year are treated as if the parent had paid them. Therefore,
these expenses are included in calculating the parent's Hope
Scholarship Credit. A child may not claim a Hope
Scholarship Credit on his/her tax return for a particular
year if the child's parent claims the child as a dependent
in that same year. (The same rules apply for the Lifetime
Learning Credit, described in the next section.)
Q13: What is the maximum Hope Scholarship Credit a taxpayer may
claim for an eligible student?
A13: Until 2002 (when the dollar limitations are indexed for
inflation), for each student who meets the eligibility
requirements, the credit amount is 100 percent of the first
$1,000 of the taxpayer's out-of-pocket expenses for
qualified tuition and related expenses, plus 50 percent of
the next $1,000 of the taxpayer's out-of-pocket expenses for
qualified tuition and related expenses. Therefore, the
maximum credit amount for the expenses of an eligible
student is $1,500. If the taxpayer is claiming a credit for
more than one person, the credit amount for each student in
the taxpayer's family is added together to determine the
maximum total credit the taxpayer may claim.
Q14: The amount a taxpayer may claim as a Hope Scholarship Credit
is gradually reduced for taxpayers with modified adjusted
gross income between $40,000 and $50,000 (between $80,000
and $100,000 for married taxpayers filing jointly). How
does this reduction work?
A14: The reduction works on a sliding scale that reflects where
the taxpayer's modified adjusted gross income is in the
phase-out range. For example, until 2002 (when the dollar
limitations on the credit and the income ranges are indexed
for inflation), if an eligible student (who is not anyone's
dependent for tax purposes) pays $2,000 or more in qualified
tuition and related expenses in a particular year, and the
student's modified adjusted gross income for the year is
$45,000 (half way along the $10,000 phase-out range), the
credit amount for the student is limited to $750. By
contrast, if the same student's modified adjusted gross
income was $35,000, the credit amount for the student would
be the maximum $1,500.
Q15: How does a taxpayer claim the Hope Scholarship Credit?
A15: The first year that the credit will be available is 1998.
Thus, taxpayers will not be able to claim the credit until
they file their 1998 tax returns in 1999. Instructions
accompanying the 1998 tax forms (for returns required to be
filed in 1999) will explain how to calculate the credit and
how to claim it on the tax return.
Q16: Is there a limit to the number of times a taxpayer may claim
the Hope Scholarship Credit for each student?
A16: Yes. The credit may be claimed in no more than two years
for each student. Thus, for example, a couple with a child
who starts as a freshman in the fall of 1998, continues as a
sophomore in 1999, and meets the eligibility requirements
may claim the credit for their child's expenses in 1998 and
again in 1999. After 1999, neither the parents, the
student, nor anyone else may claim any additional Hope
Scholarship Credits for this student's qualified tuition and
related expenses. However, in 2000 and thereafter, the
Lifetime Learning Credit may be available for this child's
expenses. Furthermore, if the couple has another child who
starts as a freshman in the fall of 1999, the couple may
claim the Hope Scholarship Credit for that child's expenses
in 1999 and one additional year.
Q17: May an individual claim both the Hope Scholarship Credit and
the Lifetime Learning Credit for a student's expenses in a
single taxable year?
A17: No. For each year in which a student meets the eligibility
requirements for the Hope Scholarship Credit, the student's
expenses may be used as the basis for a Hope Scholarship
Credit or a Lifetime Learning Credit, but not both. If, for
example, an eligible student pays more than $2,000 in
qualified tuition and related expenses during the calendar
year, the student (or the individual claiming the student as
a dependent) may not claim the Hope Scholarship Credit for
the first $2,000 of expenses and the Lifetime Learning
Credit for the rest.
Q18: If a couple has two children, one who is a freshman and one
who is a junior, may the couple claim a Hope Scholarship
Credit for the freshman's expenses and a Lifetime Learning
Credit for the junior's expenses?
A18: Yes. Assuming the applicable eligibility requirements have
been met for each credit, a taxpayer may claim the Hope
Scholarship Credit for one student's expenses and the
Lifetime Learning Credit for another student's expenses in
the same year.
Q19: May a parent or student claim a Hope Scholarship Credit for
tuition paid in advance of when the academic period begins?
A19: Generally, the credit is available only for payments of
qualified tuition and related expenses that cover an
academic period beginning in the same calendar year as the
payment is made. (An academic period begins on the first
day of classes, and does not include periods of orientation,
counseling, or vacation.) An exception, however, allows a
parent or student to claim a Hope Scholarship Credit for
payments of qualified tuition and related expenses made
during the calendar year to cover an academic period that
begins in January, February, or March of the following
taxable year. BECAUSE THE HOPE SCHOLARSHIP
CREDIT DOES NOT APPLY TO EXPENSES PAID
BEFORE JANUARY 1, 1998, THIS EXCEPTION DOES
NOT APPLY TO TUITION PAID IN 1997 TO COVER
ACADEMIC PERIODS BEGINNING IN 1998.
Q20: If a student (who is not claimed as a dependent on anyone's
Federal income tax return) pays qualified tuition and
related expenses using a combination of a Pell Grant, a
loan, a gift from a family member, and some personal
savings, what expenses may be taken into account in
calculating the Hope Scholarship Credit the student may
claim?
A20: The student may take into account only "out-of-pocket"
expenses in calculating the credit. Qualified tuition and
related expenses paid with the student's earnings, a loan, a
gift, an inheritance, or personal savings (including savings
from a qualified state tuition program) are taken into
account in calculating the credit amount. However,
qualified tuition and related expenses paid with a Pell
Grant or other tax-free scholarship, a tax-free distribution
from an Education IRA, or tax-free employer-provided
educational assistance are not taken into account in
calculating the credit amount. (The same rules apply for
the Lifetime Learning Credit, described in the next
section.)
Q21: May a student's parents claim the Hope Scholarship Credit
for the student's expenses for a taxable year in which the
student takes money out of an Education IRA on a tax-free
basis?
A21: No. If a student is receiving a tax-free distribution from
an Education IRA in a particular taxable year, none of that
student's expenses may be claimed as the basis for a Hope
Scholarship Credit for that taxable year. However, the
student may waive the tax-free treatment of the Education
IRA distribution and elect to pay any tax that would
otherwise be owed on the Education IRA distributions
received in any taxable year so that the student or the
student's parents may claim a Hope Scholarship Credit for
expenses paid in the same year the Education IRA
distributions are received.

SECTION 2. LIFETIME LEARNING CREDIT

Beginning on July 1, 1998, taxpayers may be eligible to
claim a nonrefundable Lifetime Learning Credit against their
federal income taxes. The Lifetime Learning Credit may be
claimed for the qualified tuition and related expenses of the
students in the taxpayer's family (i.e., the taxpayer, the
taxpayer's spouse, or an eligible dependent) who are enrolled in
eligible educational institutions. Through 2002, the amount that
may be claimed as a credit is equal to 20 percent of the
taxpayer's first $5,000 of out-of-pocket qualified tuition and
related expenses for all the students in the family. After 2002,
the credit amount is equal to 20 percent of the taxpayer's first
$10,000 of out-of-pocket qualified tuition and related expenses.
Thus, the maximum credit a taxpayer may claim for a taxable
year is $1,000 through 2002 and $2,000 thereafter. These
amounts are not indexed for inflation.

If the taxpayer is claiming a Hope Scholarship Credit for a
particular student, none of that student's expenses for that year
may be applied toward the Lifetime Learning Credit. The amount
a taxpayer may claim as a Lifetime Learning Credit is gradually
reduced for taxpayers who have modified adjusted gross income
between $40,000 ($80,000 for married taxpayers filing jointly)
and $50,000 ($100,000 for married taxpayers filing jointly).
Taxpayers with modified adjusted gross income over $50,000
($100,000 for married taxpayers filing jointly) may not claim a
Lifetime Learning Credit. The modified adjusted gross income
limitation will be indexed for inflation in 2002 and years
thereafter. The definition of modified adjusted gross income is
the same as it is for purposes of the Hope Scholarship Credit.
(See Sec. 1, Q&A6.)

The Lifetime Learning Credit may be claimed for payments of
qualified tuition and related expenses made on or after July 1,
1998, for academic periods beginning on or after July 1, 1998.
Therefore, the first time taxpayers will be able to claim the
credit will be when they file their 1998 tax returns in 1999.
The Lifetime Learning Credit is not available for any amount
paid in 1997.

Q1: Who may claim the Lifetime Learning Credit?
A1: An individual paying qualified tuition and related expenses
at a postsecondary educational institution may claim the
credit, provided the institution is an eligible educational
institution. Unlike the Hope Scholarship Credit, students
are not required to be enrolled at least half-time in one of
the first two years of postsecondary education. Nonresident
aliens generally are not eligible to claim the Lifetime
Learning Credit. (See Sec. 1, Q&A7.)
Q2: May an individual claim a Lifetime Learning Credit for
paying qualified tuition and related expenses for other
family members?
A2: Yes. An individual may claim the credit for his/her own
qualified tuition and related expenses and the qualified
tuition and related expenses of his/her spouse and other
eligible dependents (including children) for whom the
dependency exemption is allowed. Generally, a parent may
claim the dependency exemption for his/her unmarried child
if: (1) the parent supplies more than half the child's
support for the taxable year, and (2) the child is under age
19 or is a full-time student under age 24.
Q3: What are the eligibility requirements for the institution?
A3: They are the same requirements that apply for the Hope
Scholarship Credit. (See Sec. 1, Q&A4.)
Q4: Is the Lifetime Learning Credit available for a student
taking only one course?
A4: Yes. For example, a student who has just graduated from
high school and is taking a single course at a community
college may claim the Lifetime Learning Credit if the
student comes within the income limits and is not claimed as
a dependent by someone else.
Q5: Are qualified tuition and related expenses for graduate-level
education eligible for the Lifetime Learning Credit?
A5: Yes.
Q6: May an individual claim a Lifetime Learning Credit for more
than one family member?
A6: Yes. However, unlike the Hope Scholarship Credit, the
Lifetime Learning Credit is calculated on a per family,
rather than a per student, basis. Therefore, the maximum
available credit does not vary with the number of students
in the family. For example, if in 1999 a married individual
whose modified adjusted gross income is $35,000 pays $5,000
of qualified tuition and related expenses to attend an
eligible educational institution, the individual may claim a
$1,000 Lifetime Learning Credit. If in the same year the
individual also pays another $2,000 in qualified tuition and
related expenses for his spouse to attend an eligible
educational institution, the individual's Lifetime Learning
Credit is still $1,000.
Q7: May both the parent and a dependent child claim the Lifetime
Learning Credit for the child's qualified tuition and related
expenses in the same year?
A7: No. Either the parent or the child, but not both, may claim
the credit for the child's expenses in a particular year.
If an individual claims the child as a dependent on his/her
Federal income tax return for the year, only the individual
may claim the Lifetime Learning Credit for the child's
qualified tuition and related expenses. If no one claims
the child as a dependent on a Federal income tax return for
the year, only the child may claim the Lifetime Learning
Credit for the child's expenses.
Q8: How does a parent claim a Lifetime Learning Credit for the
qualified tuition and related expenses of a dependent child?
A8: The parent may claim the credit on his/her Federal income
tax return even if the child files his/her own tax return.
When a child is claimed as a dependent on the parent's
return, any qualified tuition and related expenses paid by
the child during the year are treated as if the parent had
paid them and, therefore, are included in calculating the
parent's Lifetime Learning Credit. A child may not claim a
Lifetime Learning Credit on his/her tax return for any year
if the child's parent claims the child as a dependent in
that same year. Also, a married taxpayer who does not file
a joint return is not eligible to claim the Lifetime Learning
Credit. (See Sec. 1, Q&A11.)
Q9: What is the maximum Lifetime Learning Credit a taxpayer may
claim?
A9: The credit is equal to 20 percent of the taxpayer's out-of-pocket
expenses for qualified tuition and related expenses
of all eligible family members, up to a maximum of $5,000 in
expenses annually through 2002. Thus, the maximum Lifetime
Learning Credit a taxpayer may claim through 2002 is $1,000.
After 2002, the credit is equal to 20 percent of the
taxpayer's out-of-pocket expenses up to a maximum of $10,000
in expenses. Thus, the maximum Lifetime Learning Credit a
taxpayer may claim after 2002 is $2,000. The maximum credit
does not change even if the taxpayer is claiming a credit
for the expenses of more than one student in the family.
Q10: What does the term "qualified tuition and related expenses"
mean for purposes of the Lifetime Learning Credit?
A10: The term "qualified tuition and related expenses" for
purposes of the Lifetime Learning Credit has the same
meaning as it does for purposes of the Hope Scholarship
Credit. (See Sec. 1, Q&A5.)
Q11: If a student (who is not claimed as a dependent on anyone's
Federal income tax return) pays qualified tuition and
related expenses using a combination of a Pell Grant, a
loan, a gift from a family member, and some personal
savings, what expenses may be taken into account in
calculating the Lifetime Learning Credit the student may
claim?
A11: The student may take into account only "out-of-pocket"
expenses in calculating the Lifetime Learning Credit.
Qualified tuition and related expenses paid with the
student's earnings, a loan, a gift, an inheritance, or
personal savings (including savings from a qualified state
tuition program) are taken into account in calculating the
credit amount. However, qualified tuition and related
expenses paid with a Pell Grant or other tax-free
scholarship, a tax-free distribution from an Education IRA,
or tax-free employer-provided educational assistance are not
taken into account in calculating the credit amount.
Q12: How does a taxpayer claim the Lifetime Learning Credit?
A12: The first year that the credit will be available is 1998.
Taxpayers will not be able to claim the credit until they
file their 1998 returns in 1999. Instructions accompanying
the 1998 tax forms (for returns required to be filed in
1999) will explain how to calculate the credit and how to
claim it on the tax return.
Q13: Is there a limit on the number of years in which a Lifetime
Learning Credit may be claimed, as there is for the Hope
Scholarship Credit?
A13: No. Unlike the Hope Scholarship Credit, there is no limit
to the number of years in which a Lifetime Learning Credit
may be claimed for each student. Thus, for example, an
individual who enrolls in one college-level class every year
would be able to claim the Lifetime Learning Credit for an
unlimited number of years, provided the individual meets the
income limits and is taking the classes at institutions that
meet the eligibility requirements. (See Q&A3 in this
section.)
Q14: May a parent or student claim a Lifetime Learning Credit for
tuition paid in advance of when the academic period begins?
A14: Generally, the credit is available only for payments of
qualified tuition and related expenses that cover an
academic period beginning in the same calendar year as the
year in which payment is made. (An academic period begins
on the first day of classes, and does not include periods of
orientation, counseling, or vacation.) An exception,
however, allows a parent or student to claim a Lifetime
Learning Credit for payments of qualified tuition and
related expenses made during the calendar year to cover an
academic period that begins in January, February, or March
of the following taxable year. BECAUSE THE LIFETIME
LEARNING CREDIT DOES NOT APPLY TO EXPENSES
PAID BEFORE JULY 1, 1998, THIS EXCEPTION DOES
NOT APPLY TO TUITION PAID BEFORE THAT DATE TO
COVER ACADEMIC PERIODS BEGINNING BEFORE
OR AFTER THAT DATE.
Q15: May a student or a student's parents take the Lifetime
Learning Credit for the student's expenses in a taxable year
in which the student takes money out of an Education IRA on
a tax-free basis?
A15: No. If a student is receiving a tax-free distribution from
an Education IRA in a particular taxable year, none of that
student's expenses may be claimed as the basis for a
Lifetime Learning Credit for that year. However, the
student may waive the tax-free treatment of the Education
IRA distribution and elect to pay any tax that would
otherwise be owed on the Education IRA distributions so that
the student or the student's parents may claim a Lifetime
Learning Credit for expenses paid in the same year the
Education IRA distributions are received.

SECTION 3. EDUCATION IRAs

Beginning January 1, 1998, taxpayers may deposit up to $500
per year into an Education IRA for a child under age 18.
Parents, grandparents, other family members, friends, and a child
him/herself may contribute to the child's Education IRA, provided
that the total contributions for the child during the taxable
year do not exceed the $500 limit. Amounts deposited in the
account grow tax-free until distributed, and the child will not
owe tax on any withdrawal from the account if the child's
qualified higher education expenses at an eligible educational
institution for the year equal or exceed the amount of the
withdrawal. If the child does not need the money for
postsecondary education, the account balance can be rolled over
to the Education IRA of certain family members who can use it for
their higher education. Amounts withdrawn from an Education IRA
that exceed the child's qualified higher education expenses in a
taxable year are generally subject to income tax and to an
additional tax of 10 percent. The Hope Scholarship Credit and
Lifetime Learning Credit may not be claimed for a student's
expenses in a taxable year in which the student takes a tax-free
withdrawal from an Education IRA.

Q1: What is an Education IRA?
A1: An Education IRA is a trust or custodial account that is
created or organized in the United States exclusively for
the purpose of paying the qualified higher education
expenses of the designated beneficiary of the account. The
account must be designated as an Education IRA when it is
created in order to be treated as an Education IRA for tax
purposes.
Q2: For whom may an Education IRA be established?
A2: An Education IRA may be established for the benefit of any
child under age 18. Contributions to the Education IRA will
not be accepted after the designated beneficiary reaches
his/her 18th birthday.
Q3: Where may an individual open an Education IRA?
A3: An individual may open an Education IRA with any bank, or
other entity that has been approved to serve as a nonbank
trustee or custodian of an individual retirement account
(IRA), and the bank or entity is offering Education IRAs.
Other entities that wish to offer Education IRAs but are not
approved to serve as IRA trustees or custodians may seek
approval by following the same IRS procedures used for
approval of other IRA nonbank trustees. See Notice 97-57,
1997-43 I.R.B. 19 (October 27, 1997).
Q4: When may a taxpayer start contributing to an Education IRA
for a child?
A4: A taxpayer may start making contributions on January 1,
1998, or at any time thereafter.
Q5: How much may be contributed to a child's Education IRA?
A5: Up to $500 per year in aggregate contributions may be made
for the benefit of any child. The contributions may be
placed in a single Education IRA or in multiple Education
IRAs.
Q6: What happens if more than $500 is contributed to an
Education IRA on behalf of a child in a calendar year?
A6: Aggregate contributions for the benefit of a particular
child in excess of $500 for a calendar year are treated as
excess contributions. If the excess contributions (and any
earnings attributable to them) are not withdrawn from the
child's account (or accounts) before the tax return for the
year is due, the excess contributions are subject to a 6
percent excise tax for each year the excess amount remains
in the account.
Q7: May contributions other than cash be made to a child's
Education IRA?
A7: No. Education IRAs are permitted to accept contributions
made in cash only.
Q8: May contributors take a deduction for contributions made to
an Education IRA?
A8: No.
Q9: Are there any restrictions on who can contribute to an
Education IRA?
A9: Any individual may contribute up to $500 to a child's
Education IRA if the individual's modified adjusted gross
income for the taxable year is no more than $95,000
($150,000 for married taxpayers filing jointly). (See Sec.
1, Q&A6 for a description of modified adjusted gross
income.) The $500 maximum contribution per child is
gradually reduced for individuals with modified adjusted
gross income between $95,000 and $110,000 (between
$150,000 and $160,000 for married taxpayers filing jointly).
For example, an unmarried taxpayer with modified adjusted
gross income of $96,500 in a taxable year could make a
maximum contribution per child of $450 for that year.
Taxpayers with modified adjusted gross income above $110,000
($160,000 for married taxpayers filing jointly) cannot make
contributions to anyone's Education IRA.
Q10: May a child contribute to his/her own Education IRA?
A10: Yes.
Q11: Does a taxpayer have to be related to the designated
beneficiary in order to contribute to the designated
beneficiary's Education IRA?
A11: No.
Q12: How many Education IRAs may a child have?
A12: There is no limit on the number of Education IRAs that may
be established designating a particular child as
beneficiary. However, in any given taxable year the total
aggregate contributions to all the accounts designating a
particular child as beneficiary may not exceed $500.
Q13: May a designated beneficiary take a tax-free withdrawal from
an Education IRA to pay qualified higher education expenses
if the designated beneficiary is enrolled less than full-time at an
eligible educational institution?
A13: Yes. Whether the designated beneficiary is enrolled full-time,
half-time, or less than half-time, he/she may take a
tax-free withdrawal to pay qualified higher education
expenses.
Q14: What happens when a designated beneficiary withdraws assets
from an Education IRA to pay for college?
A14: Generally, the withdrawal is tax-free to the designated
beneficiary to the extent the amount of the withdrawal does
not exceed the designated beneficiary's qualified higher
education expenses.
Q15: What are "qualified higher education expenses"?
A15: "Qualified higher education expenses" mean expenses for
tuition, fees, books, supplies, and equipment required for
the enrollment or attendance of the designated beneficiary
at an eligible educational institution. Qualified higher
education expenses also include amounts contributed to a
qualified state tuition program. Qualified higher education
expenses also include room and board (generally the school's
posted room and board charge, or $2,500 per year for
students living off-campus and not at home) if the
designated beneficiary is at least a half-time student at an
eligible educational institution. The standards for
determining whether a student is enrolled at least half-time
are the same as those used for the Hope Scholarship Credit.
(See Sec. 1, Q&A3.)
Q16: What is an eligible educational institution?
A16: An eligible educational institution is any college,
university, vocational school, or other postsecondary
educational institution that is described in section 481 of
the Higher Education Act of 1965 (20 U.S.C. 1088) and,
therefore, eligible to participate in the student aid
programs administered by the Department of Education. This
category includes virtually all accredited public,
nonprofit, and proprietary postsecondary institutions. (The
same eligibility requirements for institutions apply for the
Hope Scholarship Credit, the Lifetime Learning Credit, and
early withdrawals from IRAs for qualified higher education
expenses. (See Sec. 1, Q&A4, Sec. 2, Q&A3, and Sec. 4,
Q&A2.))
Q17: What happens if a designated beneficiary withdraws an amount
from an Education IRA but does not have any qualified higher
education expenses to pay in the taxable year he/she makes
the withdrawal?
A17: Generally, if a designated beneficiary withdraws an amount
from an Education IRA and does not have any qualified higher
education expenses during the taxable year, a portion of the
distribution is taxable. The taxable portion is the portion
that represents earnings that have accumulated tax-free in
the account. The taxable portion of the distribution is
also subject to a 10 percent additional tax unless an
exception applies.
Q18: Is a distribution from an Education IRA taxable if the
distribution is contributed to another Education IRA?
A18: Any amount distributed from an Education IRA and rolled over
to another Education IRA for the benefit of the same
designated beneficiary or certain members of the designated
beneficiary's family is not taxable. An amount is rolled
over if it is paid to another Education IRA on a date within
60 days after the date of the distribution. Members of the
designated beneficiary's family include the designated
beneficiary's children and their descendants, stepchildren
and their descendants, siblings and their children, parents
and grandparents, stepparents, and spouses of all the
foregoing. The $500 annual contribution limit to Education
IRAs does not apply to these rollover contributions. For
example, an older brother who has $2,000 left in his
Education IRA after he graduates from college can roll over
the full $2,000 balance to an Education IRA for his younger
sister who is still in high school without paying any tax on
the transfer.
Q19: What happens to the assets remaining in an Education IRA
after the designated beneficiary finishes his/her
postsecondary education?
A19: There are two options. The amount remaining in the account
may be withdrawn for the designated beneficiary. The
designated beneficiary will be subject to both income tax
and the additional 10 percent tax on the portion of the
amount withdrawn that represents earnings if the designated
beneficiary does not have any qualified higher education
expenses in the same taxable year he/she makes the
withdrawal. Alternatively, if the amount in the designated
beneficiary's Education IRA is withdrawn and rolled over (as
described in Q&A18 of this section) to another Education IRA
for the benefit of a member of the designated beneficiary's
family, the amount rolled over will not be taxable.
Q20: Rather than rolling over money from one Education IRA to
another, may the designated beneficiary of the account be
changed from one child to another without triggering a tax?
A20: Yes, provided: (1) the terms of the particular trust or
custodial account permit a change in designated
beneficiaries (each trustee or custodian will control
whether options like this one are available in the accounts
they offer), and (2) the new designated beneficiary is a
member of the previous designated beneficiary's family.
(See Q&A18 in this section).
Q21: May a student or the student's parents claim the Hope
Scholarship Credit or Lifetime Learning Credit for the
student's expenses in a taxable year in which the student
receives money from an Education IRA on a tax-free basis?
A21: No. If a student is receiving a tax-free distribution from
an Education IRA in a particular taxable year, none of that
student's expenses may be claimed as the basis for a Hope
Scholarship Credit or Lifetime Learning Credit for that
year. However, the student may waive the tax-free treatment
of the Education IRA distribution and elect to pay any tax
that would otherwise be owed on an Education IRA
distribution so that the student or the student's parents
may claim a Hope Scholarship Credit or Lifetime Learning
Credit for expenses paid in the same year the Education IRA
distributions are received.
Q22: May contributions be made to both a qualified state tuition
program and an Education IRA on behalf of the same
designated beneficiary in the same taxable year?
A22: No. Any amount contributed to an Education IRA on behalf of
a designated beneficiary during any taxable year in which an
amount is also contributed to a qualified state tuition
program on behalf of the same beneficiary will be treated as
an excess contribution to the Education IRA. (See Q&A6 in
this section for the treatment of excess contributions.)

SECTION 4. USING IRA WITHDRAWALS TO PAY HIGHER
EDUCATION EXPENSES

Beginning January 1, 1998, a taxpayer may make withdrawals
from an individual retirement account (IRA) to pay the qualified
higher education expenses for the taxpayer, the taxpayer's
spouse, or the child or grandchild of the taxpayer or taxpayer's
spouse at an eligible educational institution. The taxpayer will
owe federal income tax on the amount withdrawn, but will not be
subject to the 10 percent early withdrawal tax that applies when
amounts are withdrawn from an individual retirement account
before the account holder reaches age 59 1/2 .

Q1: When can an individual first make a withdrawal from an IRA
to pay for qualified higher education expenses without
paying the 10 percent early withdrawal tax?
A1: On or after January 1, 1998, an individual can make
withdrawals from his/her IRA to pay for qualified higher
education expenses for academic periods beginning on or
after January 1, 1998, without paying the 10 percent early
withdrawal tax. See Notice 97-53, 1997-40 I.R.B. 6 (October
6, 1997). The 10 percent early withdrawal tax does not
apply to a distribution from an IRA to the extent that the
amount of the distribution does not exceed the qualified
higher education expenses during the taxable year for the
taxpayer, the taxpayer's spouse, and the child or grandchild
of the taxpayer or the taxpayer's spouse at an eligible
educational institution. For purposes of this rule, the
term "qualified higher education expenses" means tuition,
fees, books, supplies, and equipment required for the
enrollment or attendance of the student at an eligible
educational institution. Qualified higher education
expenses also include room and board if the student is
enrolled at least half-time. Qualified higher education
expenses paid with an individual's earnings, a loan, a gift,
an inheritance given to the student or the individual making
the withdrawal, or personal savings (including savings from
a qualified state tuition program) are included in
determining the amount of the IRA withdrawal which is not
subject to the 10 percent early withdrawal tax. Qualified
higher education expenses paid with a Pell Grant or other
tax-free scholarship, a tax-free distribution from an
Education IRA, or tax-free employer-provided educational
assistance are excluded.
Q2: What are the requirements for an "eligible educational
institution".
A2: An "eligible educational institution" is any college,
university, vocational school, or other postsecondary
educational institution that is described in section 481 of
the Higher Education Act of 1965 (20 U.S.C. 1088) and,
therefore, eligible to participate in the student aid
programs administered by the Department of Education. This
category includes virtually all accredited public,
nonprofit, and proprietary postsecondary institutions. (The
same eligibility requirements for institutions apply for the
Hope Scholarship Credit, the Lifetime Learning Credit, and
Education IRAs. (See Sec. 1, Q&A4, Sec. 2, Q&A3, and Sec.
3, Q&A16.))
Q3: When are IRA withdrawals usually subject to the 10 percent
early withdrawal tax?
A3: Generally, if a taxpayer makes a withdrawal from his/her IRA
before reaching age 59 1/2, the taxpayer must pay the 10
percent early withdrawal tax on all or part of the amount
withdrawn.
Q4: In addition to the Education IRA, TRA '97 also created the
Roth IRA. May a taxpayer make a withdrawal from a Roth IRA
to pay for his/her child's qualified higher education
expenses without paying the 10 percent early withdrawal tax?
A4: Yes. A taxpayer may make a withdrawal from a Roth IRA, as
they can from other IRAs, to pay qualified higher education
expenses without paying the 10 percent early withdrawal tax.

SECTION. 5. STUDENT LOAN INTEREST DEDUCTION
Beginning January 1, 1998, taxpayers who have taken loans to
pay the cost of attending an eligible educational institution for
themselves, their spouse, or their dependent generally may deduct
interest they pay on these student loans. The maximum deduction
each taxpayer is permitted to take increases from $1,000 in 1998
to $2,500 in 2001 and thereafter. The following table summarizes
the yearly increases.

YEAR MAXIMUM DEDUCTION
1998 $1,000
1999 $1,500
2000 $2,000
2001 and thereafter $2,500

The deduction is available only for interest payments made
during the first 60 months in which interest payments are
required on the loan. The student loan interest deduction is
available for interest payments due and made on or after January
1, 1998. Thus, the first time taxpayers will be able to claim
the deduction is when they file their 1998 tax returns in 1999.
No student loan interest deduction will be allowed for interest
due or paid before 1998.
Q1: Are there any limits on what qualifies as a student loan?
A1: Yes. The loan must have been used to pay the costs of
attendance at an eligible educational institution for a
student enrolled at least half-time in a program leading to
a degree, certificate, or other recognized educational
credential. An eligible educational institution is any
college, university, vocational school, or other
postsecondary educational institution that is described in
section 481 of the Higher Education Act of 1965 (20 U.S.C.
1088) and, therefore, eligible to participate in the student
aid programs administered by the Department of Education.
This category includes virtually all accredited public,
nonprofit, and proprietary postsecondary institutions. For
purposes of the student loan interest deduction, eligible
educational institutions also include institutions that
conduct an internship or residency program leading to a
degree or certificate awarded by an institution of higher
education, a hospital, or a health care facility that offers
postgraduate training.
Q2: Is a student loan interest deduction available if the
student loan is not federally guaranteed or otherwise
subsidized?
A2: Yes. As long as the loan was used to pay the costs of
attendance at an eligible educational institution and the
other eligibility requirements are met, the deduction is
available for the interest on the loan. The deduction does
not depend on whether the loan is federally guaranteed or
subsidized.
Q3: What costs are included in the costs of attendance?
A3: Costs of attendance include all items that are included in
costs of attendance for purposes of calculating a student's
financial need in accordance with the Higher Education Act.
Thus, they include tuition, fees, room, board, books,
equipment, and other necessary expenses, such as
transportation. Costs of attendance include more items than
are included in qualified tuition and related expenses for
purposes of the Hope Scholarship and Lifetime Learning
Credits. (See Sec. 1, Q&A5 and Sec. 2, Q&A10.)
Q4: Is the deduction available for interest paid on loans used
to pay for graduate school?
A4: Yes.
Q5: Are there any limits on who may take the student loan
interest deduction?
A5: Yes, there are income restrictions. To claim the maximum
deduction, a taxpayer must have modified adjusted gross
income of $40,000 or less ($60,000 for married taxpayers
filing jointly). The amount of the taxpayer's deduction is
gradually reduced for taxpayers with modified adjusted gross
income between $40,000 and $55,000 (between $60,000 and
$75,000 for married taxpayers filing jointly). For example,
for 1998, the maximum deduction a single taxpayer with
modified adjusted gross income of $47,500 could take would
be $500. Taxpayers with modified adjusted gross income
above $55,000 ($75,000 for married taxpayers filing jointly)
may not claim the student loan interest deduction. The
modified adjusted gross income limitations are indexed for
inflation after 2002.
Q6: May former students whose loans are already in repayment
deduct the interest they pay on a student loan on or after
January 1, 1998?
A6: Yes, but they may deduct only those payments made during the
first 60 months that interest payments are required on a
loan. If interest payments on a student loan were first
required before January 1, 1998, the months in which those
payments were required count against the 60-month time limit
for that loan. The 60-month period may run out at different
times for different loans.
Q7: May a parent claim the student loan interest deduction if
the parent borrows to pay his/her child's costs of attending
college?
A7: Yes. An individual may claim the student loan interest
deduction if the individual borrows money to pay the costs
of attending college for certain members of the individual's
family or household (including his/her children) and incurs
the debt in a year in which the individual supplies more
than half of the student's support.
Q8: If an individual has paid more than $1,000 in interest on
student loans in 1998 and is otherwise eligible to take the
maximum student loan interest deduction, how large a
deduction may the individual claim?
A8: The individual's student loan interest deduction for 1998 is
$1,000, provided the individual's modified adjusted gross
income falls below the point where the deduction is reduced
or eliminated.
Q9: Does an individual have to itemize his/her income tax
deductions to claim the student loan interest deduction?
A9: No. The student loan interest deduction is available
regardless of whether an individual elects to take the
standard deduction or to itemize deductions. Instructions
accompanying the 1998 tax forms (for returns required to be
filed in 1999) will explain how to compute and claim the
deduction.
Q10: If a student is claimed as a dependent by his/her parent in
a particular taxable year, may the student take the student
loan interest deduction for student loan interest that
he/she pays in that year?
A10: No. The student may not claim the student loan interest
deduction in any taxable year in which he/she is claimed as
a dependent on another taxpayer's Federal income tax return.
student loan and meets the other eligibility requirements,
the student may claim the student loan interest deduction
for payments made in a later year when the student is no
longer a dependent on his/her parent's Federal income tax
return.
Q11: Are there any tax benefits available if the student repays
his/her loan by performing community service rather than
making cash payments?
A11: There may be. Loan forgiveness provided in return for
community service is tax-free when it is part of certain
lending programs run by Federal, state, or local
governments, educational institutions, or charitable
organizations. Students should consult a tax advisor to
determine whether they qualify.

SECTION 6. QUALIFIED STATE TUITION PROGRAMS

Under current law, a qualified state tuition program (QSTP)
means a program established and maintained by a state under which
a person may: (1) prepay tuition benefits on behalf of a
beneficiary so that the beneficiary is entitled to a waiver or a
payment of qualified higher education expenses, or (2) contribute
to an account that is established for paying qualified higher
education expenses of the beneficiary. The tax on earnings
attributable to prepayments or contributions is deferred until
the earnings are distributed from the QSTP. The beneficiary pays
tax on the earnings at the time of distribution. If amounts
saved through a QSTP are used to pay for college, the student or
the student's parents still may be eligible to claim either the
Hope Scholarship Credit or the Lifetime Learning Credit.

Q1: How have the prior rules for QSTPs been changed by TRA '97?
A1: (1) QSTPs may now be used to save for room and board
expenses, up to a specified level (generally the school's
posted room and board charge, or $2,500 per year for
students living off-campus and not at home);
(2) QSTPs may now be used to pay expenses not only at public
and nonprofit institutions but also at proprietary schools
(i.e., any school that is an eligible educational
institution for purposes of the Hope Scholarship or Lifetime
Learning Credits, see Sec. 1, Q&A4);
(3) Accounts in QSTPs may now be transferred tax-free from
the beneficiary to a broader range of family members.
(Step-siblings and spouses of family members have been added.)
Q2: May a student using a QSTP to pay for college also benefit
from the Hope Scholarship Credit or Lifetime Learning
Credit?
A2: Yes. The student or the student's parent may claim a Hope
Scholarship Credit or Lifetime Learning Credit for qualified
tuition and related expenses covered by a qualified state
tuition program, provided the other eligibility requirements
for the credits are met.
Q3: When are the changes to the QSTP rules made by TRA '97
effective?
A3: Generally, the new rules go into effect on January 1, 1998.
However, the new provision permitting QSTPs to be used to
save for room and board expenses is effective back to August
20, 1996.
Q4: May contributions be made to both a qualified state tuition
program and an Education IRA on behalf of the same
designated beneficiary in the same taxable year?
A4: No. Any amount contributed to an Education IRA on behalf of
a designated beneficiary during any taxable year in which an
amount is also contributed to a qualified state tuition
program on behalf of the same beneficiary will be treated as
an excess contribution to the Education IRA. (See Sec. 3,
Q&A6 for the treatment of excess contributions to an
Education IRA.)

SECTION 7. EXCLUSION FOR EMPLOYER-PROVIDED
EDUCATIONAL ASSISTANCE

TRA '97 extends tax-free treatment to employer-provided
educational assistance for undergraduate courses that begin
before June 1, 2000. Employers may continue to provide up to
$5,250 per year in educational assistance to each employee on a
tax-free basis for courses beginning before that date, regardless
of whether the education is job-related. This benefit expires
for assistance in paying for courses that begin on or after June
1, 2000.

Q1: How does an employee learn whether tax-free educational
assistance is available to him/her?
A1: Employers have this information. Employers offering
tax-free educational assistance are required to have a written
plan describing the benefit and the terms under which it is
available.
Q2: Does the employee have to do anything special to avoid being
taxed on employer-provided educational assistance, up to the
$5,250 limit?
A2: No. The employer will automatically treat the educational
assistance as a tax-free benefit and will not include it as
wages on the employee's W-2 form.
Q3: May an employee receive tax-free educational assistance from
the employer to attend graduate school?
A3: In general, no. However, employers can provide job-related
educational assistance for graduate-level education as a
tax-free fringe benefit under certain circumstances.
Educational assistance would generally qualify as
job-related if it maintains or improves skills required for the
employee's current job or satisfies certain express
employer-imposed conditions for continued employment.
Individuals should consult a tax advisor for help in
determining the tax treatment of any assistance the
individual may be receiving from an employer for
graduate-level education.
Q4: If a student is enrolled in undergraduate courses in a
particular year and owes $3,000 in qualified tuition and
related expenses, and the student's employer pays all of the
student's qualified tuition and related expenses, may a Hope
Scholarship Credit or a Lifetime Learning Credit be claimed
for that student for that year?
A4: No. Neither the Hope Scholarship Credit nor the Lifetime
Learning Credit may be claimed for that student for that
year.

FOR FURTHER INFORMATION CONTACT: Donna J. Welch,
(202) 622-4910 regarding the Hope Scholarship and Lifetime
Learning Credits; Monice L. Rosenbaum, (202) 622-6070
regarding employer-provided educational assistance and qualified
state tuition programs; Pamela R. Kinard, (202) 622-6030 regarding
Education IRAs and using IRA withdrawals to pay for higher
education expenses; and John Moriarty, (202) 622-4950 regarding
student loan interest deduction (not toll-free numbers).

The IRS will publish additional guidance on the provisions
discussed in this notice as well as other provisions included in
TRA 97. You may visit the IRS worldwide web site at
(http://www.irs.ustreas.gov/prod/hot/index.html) to review this
document or for information on additional guidance as it becomes
available.

The Department of Education has a worldwide web site
(http://www.ed.gov/prog_info/SFA/StudentGuide) you can visit and
telephone numbers (1-800-4FED-AID and 1-800-USA-LEARN) you
can call to get more information on affording college and obtaining
student aid, such as Pell grants and student loans.

DRAFTING INFORMATION: The principal authors of this notice are
Donna J. Welch, Office of Assistant Chief Counsel (Income Tax
and Accounting) and Monice L. Rosenbaum and Pamela R. Kinard,
Office of Associate Chief Counsel (Employee Benefits and Exempt
Organizations). However, other personnel from the IRS and
Treasury Department participated in its development.