Unintended Consequences of GOP Tax Law

A provision in the Republican tax law passed in 2017 could actually mean a hike in the tax bill for many low-income families with a student receiving scholarships for college, a top higher ed group warned lawmakers this month.

Scholarships or grants for nontuition expenses like room and board have traditionally been subject to the same marginal tax rate paid by parents. So low-income students could expect to pay low taxes. But the Tax Cuts and Jobs Act applies the same high marginal tax rates for those scholarships as it does for trusts and estates.

“Now these students are being taxed at the same rates as wealthy individuals,” wrote Ted Mitchell, president of the American Council on Education, in a letter to key lawmakers.

The issue, which was first reported by The New York Times, only recently began to register with college groups as the filing deadline approached for the 2018 tax period, the first since the law took effect.

Lawmakers say they’re planning to take quick action on the issue. Representative Richard Neal, the Democratic chairman of the House Ways and Means committee, will introduce an amendment this week to restore the previous tax rates, a spokeswoman said. Neal plans to attach the amendment to a retirement savings bill being considered by the House that has bipartisan support. That fix would apply retroactively, the spokeswoman said.

The Senate finance committee did not respond to a request for comment. But a spokesman for Senator Chuck Grassley, the chairman of the committee, told the Times that the Iowa Republican wanted to quickly reach an agreement to fix the issue.

In the run-up to the passage of the tax law in 2017, higher ed groups focused on stripping out provisions that explicitly targeted higher ed benefits. Early versions of the legislation, for example, would have eliminated tax deductions for graduate students and student borrowers.

The higher ed lobby also tried unsuccessfully to block the creation of an endowment tax hitting the wealthiest private institutions. ACE and private college leaders have backed legislation to repeal the tax on endowments.

But the change to taxes on student scholarships flew under the radar -- partly because it was so arcane.

“That’s what happens when you’re writing a very complicated bill and it gets passed very quickly,” said Steven Bloom, director of government and public affairs at ACE. “It’s inevitable that these technical problems are going to surface later.”

The tax hike for low-income families could be substantial, as Mitchell laid out in his letter to lawmakers. A two-parent household with an income of $50,000 could face an additional $1,200 tax on a full scholarship to a private university, he said. And the higher the amount of the scholarship, the larger the tax bill that would hit those families.

The changes to the so-called kiddie tax on need-based scholarships and grants don’t just affect low-income students. They also affect college athletes on full scholarship as well as Native American students receiving some tribal payments and “gold star” families receiving survivor benefits.

And the higher tax rates aren’t just a challenge for students on scholarship at private colleges. David Baime, senior vice president for government relations and policy analysis at the American Association of Community Colleges, said students at two-year colleges would be taxed on the portion of their Pell Grants that helps meet living expenses.

Republicans, who controlled the House and Senate when the bill was passed in 2017, had argued the new law would achieve a long-held goal of simplifying the tax code, including the kiddie tax, which was originally created to prevent wealthy individuals from lowering their tax hit by steering income to their children.

But congressional GOP officials told the Times that higher tax rates on college scholarships were an unintended consequence.

Brian Flahaven, senior director of advocacy at the Council for Advancement and Support of Education, said donors to scholarship programs expect that their contributions will go to students to actually afford college, not create bigger tax burdens for their families.

“There seems to be a recognition that, yeah, this is something that needs to be fixed,” he said.