Thanks to Chuck Moore and the College Literacy Academy for Providing this Update. 

GAO Report May 2008
(US Government Accountability Office)

Multiple Higher Education Tax Incentives Create Opportunities for Taxpayers to Make Costly Mistakes.

Some tax filers do not appear to make optimal education-related tax decisions. For example, our analysis of a limited number of 2005 tax returns indicated that 19 percent of eligible tax filers did not claim either the tuition deduction or a tax credit. In so doing, these tax filers failed to reduce their tax liability by $219, on average, and 10 percent of these filers could have reduced their tax liability by over $500. One explanation for these taxpayers’ choices may be the complexity of postsecondary tax provisions, which experts have commonly identified as difficult for tax filers to use.

Individual taxpayers’ choices were not limited to tax filers who prepared their own tax returns. A possible indicator of the difficulty people face in understanding education-related tax preferences is how often the suboptimal choices we identified were found on tax returns prepared by paid tax preparers. We estimate that 50 percent of the returns we found that appear to have failed to optimally reduce the tax filer’s tax liability were prepared by paid tax preparers.

Generalized to the population of tax returns we were able to review, returns prepared by paid tax preparers represent about 301,000 of the approximately 601,000 suboptimal choices we found. Our April 2006 study of paid tax preparers corroborates the problem of confusion over which of the tax preferences to claim (GAO, Paid Tax Return Preparers: In a Limited Study, Chain Preparers Made Serious Errors, GAO-06-563T ). 

Of the nine undercover investigation visits we made to paid preparers with a taxpayer with a dependent college student, three preparers did not claim the credit most advantageous to the taxpayer and thereby cost these taxpayers hundreds of dollars in refunds. In our investigative scenario, the expenses and the year in school made the Hope education credit far more advantageous to the taxpayer than either the tuition and fees deduction or the Lifetime Learning credit.

The apparently suboptimal use of postsecondary tax preferences may arise, in part, because of the complexity of using these provisions. Tax policy analysts have frequently identified postsecondary tax preferences as a set of tax provisions that demand a particularly large investment of knowledge and skill on the part of students and families or expert assistance purchased by those with the means to do so.

They suggest that this complexity arises from multiple postsecondary tax preferences with similar purposes, from key definitions that vary across these provisions, and from rules that coordinate the use of multiple tax provisions. Twelve tax preferences are outlined in IRS Publication 970, (Tax Benefits for Education: For Use in Preparing 2007 Returns). The publication includes four different tax preferences for educational saving. Three of these preferences-Coverdell Education Savings Accounts, Qualified Tuition Programs, and U.S. education savings bonds-differ across more than a dozen dimensions, including the tax penalty that occurs when account balances are not used for qualified higher education expenses, who may be an eligible beneficiary, annual contribution limits, and other features.

In addition to learning about, comparing, and selecting tax preferences, filers who wish to make optimal use of multiple tax preferences must understand how the use of one tax preference affects the use of others.

The use of multiple education-related tax preferences is coordinated through rules that prohibit the application of the same qualified higher education expenses for the same student to more than one education-related tax preference, sometimes referred to as “anti-double-dipping rules.” These rules are important because they prevent tax filers from underreporting their tax liability. Nonetheless, anti-double-dipping rules are potentially difficult for tax filers to understand and apply, and misunderstanding them may have consequences for a filer’s tax liability.

If we can help you prepare better for next year’s tax season, please don’t hesitate to contact us at info@dreamstrategy.com, or call us at 603-226-8665.