The Personal Income Tax Law, in modified conformity with federal income tax laws, allows various deductions in computing the income that is subject to the taxes imposed by that law.

This bill would allow a deduction in computing adjusted gross income for those amounts contributed to a Coverdell education savings account, up to $750 per taxable year, as provided.

This bill would take effect immediately as a tax levy.

Date of Hearing: May 18, 2015

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Philip Ting, Chair

ABPCA Bill Id:AB 1041 (

Author:Baker) – As Introduced Ver:February 26, 2015

SUSPENSE

Majority vote. Fiscal committee. Tax levy.

SUBJECT: Personal income taxes: education savings accounts.

SUMMARY: Provides an "above-the-line" deduction for amounts contributed to a Coverdell Education Savings Account (ESA) from gross income, up to $750 per taxable year. Specifically, this bill:

1. Provides a deduction for an amount contributed by a taxpayer during the taxable year to an ESA, not to exceed $750 per taxable year, except as otherwise provided.

2. Defines a “coverdell education savings account” by reference to the Internal Revenue Code (IRC) Section 530, as modified by Revenue and Taxation Code (R&TC) Section 23712.

3. Provides that for purposes of applying IRC Section 530, the basis for the ESA shall be reduced by an amount equal to this deduction.

4. Provides that for taxable years beginning on or after January 1, 2014, IRC Section 62(a) is modified to provide that this deduction shall be allowed in computing adjusted gross income.

5. Takes effect immediately as a tax levy.

EXISTING LAW:

1. Conforms to IRC Section 530 as of the “specified date” of January 1, 2009, with modifications, and thus generally conforms to the federal rules that apply to qualified education expenses. California modifies the additional 10-percent tax on excess distributions to instead be an additional tax of 2.5 percent for state purposes. California law does not allow a deduction for qualified higher education expenses. IRC Section 530 provides for the use of ESAs, which are used exclusively for the purpose of paying qualified education expenses of a named beneficiary. ESAs are an investment trust account specifically designated for qualified education costs, which include both K-12 expenses and higher education expenses. For 2013, the maximum annual contributions to an ESA may not exceed $2,000 per designated beneficiary and may not be made after the designated beneficiary reaches age 18, except in cases of a special needs beneficiary. Provides a phase out of contributions for taxpayers with modified AGI between 95,000 and 110,000 ($190,000 and $220,000 for married taxpayers filing a joint return).

2. Defines "qualified educational expenses," under IRC Section 530, to include "qualified higher education expenses" and "qualified elementary and secondary education expenses." The term “qualified higher education expenses” includes tuition, fees, books, supplies, and equipment required for the enrollment or attendance of the designated beneficiary at an eligible education institution, regardless of whether the beneficiary is enrolled at an eligible educational institution on a full-time, half-time, or less than half-time basis. The funds for "qualified elementary and secondary education expenses" can be used to cover the costs of attending elementary and secondary school. In addition to tuition, these costs can include uniforms, tutoring, computers, software, and transportation.

3. Provides that contributions to an ESA are not tax-deductible, but the earning grow-tax free, and so do withdrawals, as long as the distributions are used for qualified education expenses. However, ESAs are subject to the unrelated business income tax imposed by IRC section 511. Distributions from an ESA are excludable from the gross income of the distributee (i.e., the student) to the extent that the distribution does not exceed the qualified education expenses incurred by the beneficiary during the year the distribution is made. The earnings portion of an ESA distribution not used to pay qualified education expenses is includible in the gross income of the distributee and generally is subject to an additional 10-percent tax.¹

4. Conforms to IRC Section 529 as of the "specified date" of January 1, 2009, with certain modifications, including a modification to the 10% tax on excess distributions to instead be an additional tax of 2.5% for state purposes.

5. Provides its own IRC Section 529 qualified tuition program, known as the Golden State Scholarshare Trust (ScholarShare). ScholarShare enables taxpayers to save for college by putting money in tax-advantaged investments. After-tax contributions allow earnings to grow tax-deferred, and disbursements, when used for tuition and other qualified expenses, are federal and state tax-free. Distributions in excess of qualified higher education expenses incurred for the beneficiary is generally subject to income tax and an additional 2.5% tax for state purposes. Limits the total amount of contributions to a beneficiary in a 529 qualified tuition program to $371,000. Accounts that have reached the limit may continue to accrue earnings.

FISCAL EFFECT: The Franchise Tax Board (FTB) estimates General Fund revenue loss of $350,000 in fiscal year (FY) 2015-16, $450,000 in FY 2016-17, and $450,000 in FY 2017-18.

COMMENTS:

1. Author's Statement: The author has provided the following statement in support of this bill:

This bill proposes a new state tax deduction of up to $750 for contributions made to Coverdell education savings accounts that will encourage parents to invest in their children's kindergarten through college education. The deduction would be "above the line," which means it will be available to all taxpayers regardless of whether they itemize deductions on their tax returns. By providing an additional incentive for more people to save money for their child's kindergarten through college education, children will benefit in the long term with a more solid foundation upon which to further their education.

2. Arguments in Support: The California Catholic Conference states that, “[f]inancial pressures weighing upon California families have made it difficult to ensure a quality elementary and secondary education and to generate funds for college. While families can set aside funds in support of their children’s learning needs as they arise through a Coverdell ESA, additional state tax relief is needed to encourage such educational planning.”

2. Arguments in Opposition: The American Federation of State, County and Municipal Employees states that it “opposes this bill because it would appear to benefit those who are least in need of help in covering college costs by requiring a level of savings that low-income individuals and families cannot provide. We believe that the funds generated from this tax break could be better used and put towards lowering tuition, improving CalGrants, and improving access to higher education.”

4. Favoring Higher Income Earners. According to a report by the Government Accountability Office (GAO), less than 3% of families have 529 or ESA plans and those who do tend to be wealthier. (Higher Education: A Small Percentage of Families Save in 529 Plans, GAO, Dec. 2012.) Specifically, families with 529 and ESA plans had a median income of $142,000 per year and a median financial asset value of about $413,500. It was also said that families with 529 and ESA plans tend to have higher levels of education, which may increase the likelihood that their children will attend college.

The report outlined several reasons why low-income families participate far less in 529 and ESA plans, such as a lack of awareness, confusion as to how the plan works, and differences among the various plans. However, 68% of those surveyed stated a lack of money as the major reason for not participating. In the end, it is difficult to encourage families to save for college when they have little or no disposable income.

4. High Cost of a Formal Education. State support for higher education has been dramatically reduced because of budget crises over the last 10 years. According to a study by the Public Policy Institute of California, in 2010-11 California spent $1.6 billion less in higher education than it did 10 years earlier, adjusted for inflation. (Hans Johnson, Defunding Higher Education: What are the Effects on College Enrollment, Public Policy Institute of California, May 2012.) The provisions of this bill are meant to counteract the skyrocketing costs of an education by providing a deduction for contributions made to ESA. Instead of forgoing General Fund revenues that predominantly favor higher income earners, these funds may be better utilized if directly appropriated to the state's University of California, California State University, and Community College system.

4. Proposition 30. In general, Proposition 30 increased the marginal tax rate for those making above $250,000 and increased the statewide sales tax rate from 7.25% to 7.5%. Proposition 30 was estimated to increase General Fund revenue by about $6 billion per year, which would primarily be used to restore funding to California's public school system. The provisions of this bill are meant to counteract the lack of funding once available to K-12 education. Specifically, this bill seeks to remedy the fact that many schools are unable to provide school supplies and books. However, as noted in the Governor's Budget Summary, the budget for FY 2014-15 provides $61.6 billion in Proposition 98 funding, an increase of $6.3 billion over the 2013 budget act level. It appears that new revenues, provided in part because of the passage of Proposition 30, have translated into additional funding for California's K through 12 school system.

4. Is This Bill Needed? The California Supreme Court ruled in Hartzell v. Connell (1984) 35 Cal.3d 899, 201) that pupil fees violate the constitutional right to a free education. Specifically, the court ruled that extracurricular activities also must be free because they are an integral component of public education and a part of the educational program. In September 2010, the American Civil Liberties Union (ACLU) filed a class action lawsuit alleging the unconstitutional assessment of pupil fees by school districts [Jane Doe, et al. v. State of California, et al., (Super. Ct. Los Angeles County, 2010, BC445151)]. The lawsuit was brought forward because ACLU reports showed that more than 50 public school districts required pupils to pay fees for textbooks, workbooks, science labs, physical education uniforms, classroom materials, and extracurricular activities. Instead of moving forward with the lawsuit, the ACLU and interested parties sought a legislative solution. As a result, AB 1575 (Lara), Chapter 776, Statutes of 2012, which was sponsored by ACLU, codified the long held constitutional prohibition on the imposition of pupil fees and established procedures to ensure compliance with the prohibition.

Since the passage of AB 1575, many schools have stopped imposing fees for participation and, in some cases, are paying for items that were traditionally paid for by pupils and parents. Most recently, school districts have informed parents that caps and gowns will be provided free of charge. Within the last year, parents throughout California have been utilizing compliance procedures to challenge school districts that require families to pay for Advanced Placement exams, classrooms supplies, workbooks, and school uniforms. (Loretta Kalb, California to Schools: Student don’t have to pay for graduation attire, other items 'integral' to education, Sacramento Bee, May 7, 2014.) In some cases, parents and activists are even challenging "supply lists" posted by school for returning student. One parent, in the San Juan School District, received a letter outlining a list of supplies that children would need at the beginning of the year. The list included items such as tissue paper, binders, pencils and pens. The supplies cost parents between $70 and $100. In response to the challenge to required supplies, the school notified parents that all necessary materials will be provided to school children and that "supply lists" are suggestions, not required for full participation. Schools across California have begun making similar changes to "required" items and fees that are imposed on pupils. In most cases, schools have stated that items will be provided free of charge.

8. Private School Subsidy: Unlike a 529 College Savings plan, ESA plans allow taxpayers to withdraw and make payments for K-12 educational expenses. K-12 educational expenses, however, are not limited to public schools. Funds can also be used to pay for private school tuition. The Committee may wish consider whether subsidizing private education and educational courses is an appropriate use of public funds.

REGISTERED SUPPORT / OPPOSITION:

Support

California Association of Private School Organization

California Catholic Conference

Opposition

American Federation of State, County and Municipal

Employees (AFSCME), AFL-CIO

Analysis Prepared by: Carlos Anguiano / REV. & TAX. / (916) 319-2098

Date of Hearing: May 11, 2015

ASSEMBLY COMMITTEE ON REVENUE AND TAXATION

Philip Ting, Chair

ABPCA Bill Id:AB 1041

Author:(Baker) – As Introduced Ver:February 26, 2015

Majority vote. Tax levy.

SUBJECT: Personal income taxes: education savings accounts

SUMMARY: Provides an "above-the-line" deduction for amounts contributed to a Coverdell Education Savings Account (ESA) from gross income, up to $750 per taxable year. Specifically, this bill:

1. Provides a deduction for an amount contributed by a taxpayer during the taxable year to an ESA, not to exceed $750 per taxable year, except as otherwise provided.

2. Defines a “coverdell education savings account” by reference to the Internal Revenue Code (IRC) Section 530, as modified by Revenue and Taxation Code (R&TC) Section 23712.

3. Provides that for purposes of applying IRC Section 530, the basis for the ESA shall be reduced by an amount equal to this deduction.

4. Provides that for taxable years beginning on or after January 1, 2014, IRC Section 62(a) is modified to provide that this deduction shall be allowed in computing adjusted gross income.

5. Takes effect immediately as a tax levy.

EXISTING LAW:

1. Conforms to IRC Section 530 as of the “specified date” of January 1, 2009, with modifications, and thus generally conforms to the federal rules that apply to qualified education expenses. California modifies the additional 10-percent tax on excess distributions to instead be an additional tax of 2.5 percent for state purposes. California law does not allow a deduction for qualified higher education expenses. IRC Section 530 provides for the use of ESAs, which are used exclusively for the purpose of paying qualified education expenses of a named beneficiary. ESAs are an investment trust account specifically designated for qualified education costs, which include both K-12 expenses and higher education expenses. For 2013, the maximum annual contributions to an ESA may not exceed $2,000 per designated beneficiary and may not be made after the designated beneficiary reaches age 18, except in cases of a special needs beneficiary. Provides a phase out of contributions for taxpayers with modified AGI between 95,000 and 110,000 ($190,000 and $220,000 for married taxpayers filing a joint return).

2. Defines "qualified educational expenses," under IRC Section 530, to include "qualified higher education expenses" and "qualified elementary and secondary education expenses." The term “qualified higher education expenses” includes tuition, fees, books, supplies, and equipment required for the enrollment or attendance of the designated beneficiary at an eligible education institution, regardless of whether the beneficiary is enrolled at an eligible educational institution on a full-time, half-time, or less than half-time basis. The funds for "qualified elementary and secondary education expenses" can be used to cover the costs of attending elementary and secondary school. In addition to tuition, these costs can include uniforms, tutoring, computers, software, and transportation.

3. Provides that contributions to an ESA are not tax-deductible, but the earning grow-tax free, and so do withdrawals, as long as the distributions are used for qualified education expenses. However, ESAs are subject to the unrelated business income tax imposed by IRC section 511. Distributions from an ESA are excludable from the gross income of the distributee (i.e., the student) to the extent that the distribution does not exceed the qualified education expenses incurred by the beneficiary during the year the distribution is made. The earnings portion of an ESA distribution not used to pay qualified education expenses is includible in the gross income of the distributee and generally is subject to an additional 10-percent tax.¹

4. Conforms to IRC Section 529 as of the "specified date" of January 1, 2009, with certain modifications, including a modification to the 10% tax on excess distributions to instead be an additional tax of 2.5% for state purposes.

5. Provides its own IRC Section 529 qualified tuition program, known as the Golden State Scholarshare Trust (ScholarShare). ScholarShare enables taxpayers to save for college by putting money in tax-advantaged investments. After-tax contributions allow earnings to grow tax-deferred, and disbursements, when used for tuition and other qualified expenses, are federal and state tax-free. Distributions in excess of qualified higher education expenses incurred for the beneficiary is generally subject to income tax and an additional 2.5% tax for state purposes. Limits the total amount of contributions to a beneficiary in a 529 qualified tuition program to $371,000. Accounts that have reached the limit may continue to accrue earnings.

FISCAL EFFECT: The Franchise Tax Board (FTB) estimates General Fund revenue loss of $350,000 in fiscal year (FY) 2015-16, $450,000 in FY 2016-17, and $450,000 in FY 2017-18.

COMMENTS:

1. Author's Statement: The author has provided the following statement in support of this bill:

This bill proposes a new state tax deduction of up to $750 for contributions made to Coverdell education savings accounts that will encourage parents to invest in their children's kindergarten through college education. The deduction would be "above the line," which means it will be available to all taxpayers regardless of whether they itemize deductions on their tax returns. By providing an additional incentive for more people to save money for their child's kindergarten through college education, children will benefit in the long term with a more solid foundation upon which to further their education.

2. Arguments in Support: The California Catholic Conference states that, “[f]inancial pressures weighing upon California families have made it difficult to ensure a quality elementary and secondary education and to generate funds for college. While families can set aside funds in support of their children’s learning needs as they arise through a Coverdell ESA, additional state tax relief is needed to encourage such educational planning.”

3. Favoring Higher Income Earners. According to a report by the Government Accountability Office (GAO), less than 3% of families have 529 or ESA plans and those who do tend to be wealthier. (Higher Education: A Small Percentage of Families Save in 529 Plans, GAO, Dec. 2012.) Specifically, families with 529 and ESA plans had a median income of $142,000 per year and a median financial asset value of about $413,500. It was also said that families with 529 and ESA plans tend to have higher levels of education, which may increase the likelihood that their children will attend college.

The report outlined several reasons why low-income families participate far less in 529 and ESA plans, such as a lack of awareness, confusion as to how the plan works, and differences among the various plans. However, 68% of those surveyed stated a lack of money as the major reason for not participating. In the end, it is difficult to encourage families to save for college when they have little or no disposable income.

3. High Cost of a Formal Education. State support for higher education has been dramatically reduced because of budget crises over the last 10 years. According to a study by the Public Policy Institute of California, in 2010-11 California spent $1.6 billion less in higher education than it did 10 years earlier, adjusted for inflation. (Hans Johnson, Defunding Higher Education: What are the Effects on College Enrollment, Public Policy Institute of California, May 2012.) The provisions of this bill are meant to counteract the skyrocketing costs of an education by providing a deduction for contributions made to ESA. Instead of forgoing General Fund revenues that predominantly favor higher income earners, these funds may be better utilized if directly appropriated to the state's University of California, California State University, and Community College system.

3. Proposition 30. In general, Proposition 30 increased the marginal tax rate for those making above $250,000 and increased the statewide sales tax rate from 7.25% to 7.5%. Proposition 30 was estimated to increase General Fund revenue by about $6 billion per year, which would primarily be used to restore funding to California's public school system. The provisions of this bill are meant to counteract the lack of funding once available to K-12 education. Specifically, this bill seeks to remedy the fact that many schools are unable to provide school supplies and books. However, as noted in the Governor's Budget Summary, the budget for FY 2014-15 provides $61.6 billion in Proposition 98 funding, an increase of $6.3 billion over the 2013 budget act level. It appears that new revenues, provided in part because of the passage of Proposition 30, have translated into additional funding for California's K through 12 school system.

3. Is This Bill Needed? The California Supreme Court ruled in Hartzell v. Connell (1984) 35 Cal.3d 899, 201) that pupil fees violate the constitutional right to a free education. Specifically, the court ruled that extracurricular activities also must be free because they are an integral component of public education and a part of the educational program. In September 2010, the American Civil Liberties Union (ACLU) filed a class action lawsuit alleging the unconstitutional assessment of pupil fees by school districts [Jane Doe, et al. v. State of California, et al., (Super. Ct. Los Angeles County, 2010, BC445151)]. The lawsuit was brought forward because ACLU reports showed that more than 50 public school districts required pupils to pay fees for textbooks, workbooks, science labs, physical education uniforms, classroom materials, and extracurricular activities. Instead of moving forward with the lawsuit, the ACLU and interested parties sought a legislative solution. As a result, AB 1575 (Lara), Chapter 776, Statutes of 2012, which was sponsored by ACLU, codified the long held constitutional prohibition on the imposition of pupil fees and established procedures to ensure compliance with the prohibition.

Since the passage of AB 1575, many schools have stopped imposing fees for participation and, in some cases, are paying for items that were traditionally paid for by pupils and parents. Most recently, school districts have informed parents that caps and gowns will be provided free of charge. Within the last year, parents throughout California have been utilizing compliance procedures to challenge school districts that require families to pay for Advanced Placement exams, classrooms supplies, workbooks, and school uniforms. (Loretta Kalb, California to Schools: Student don’t have to pay for graduation attire, other items 'integral' to education, Sacramento Bee, May 7, 2014.) In some cases, parents and activists are even challenging "supply lists" posted by school for returning student. One parent, in the San Juan School District, received a letter outlining a list of supplies that children would need at the beginning of the year. The list included items such as tissue paper, binders, pencils and pens. The supplies cost parents between $70 and $100. In response to the challenge to required supplies, the school notified parents that all necessary materials will be provided to school children and that "supply lists" are suggestions, not required for full participation. Schools across California have begun making similar changes to "required" items and fees that are imposed on pupils. In most cases, schools have stated that items will be provided free of charge.

6. Private School Subsidy: Unlike a 529 College Savings plan, ESA plans allow taxpayers to withdraw and make payments for K-12 educational expenses. K-12 educational expenses, however, are not limited to public schools. Funds can also be used to pay for private school tuition. The Committee may wish consider whether subsidizing private education and educational courses is an appropriate use of public funds.

REGISTERED SUPPORT / OPPOSITION:

Support

California Catholic Conference

Opposition

None on file

Analysis Prepared by: Carlos Anguiano / REV. & TAX. / (916) 319-2098