U.S. Capitol Building - February 17, 2012. (c) PublicDomainPictures - Pixabay
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Here’s some potentially good news for low-income students: Democrats and at least some Republicans agree that Pell Grants should no longer be taxed.

Currently, Pell Grants that are used to pay for tuition, fees, and course materials such as books are not taxable. However, Pell Grants that are used to pay for living expenses, such as room and board, are included in a filer’s gross income and are therefore taxable.

Last fall, the Consortium for Higher Education Tax Reform, of which New America is a member, called for lawmakers to eliminate the taxation of Pell Grants. “Pell Grant recipients are typically the students most in need of additional financial assistance,” our consortium wrote. “The current policy of taxing Pell Grants spent on necessary educational expenses such as room and board does not make sense given high levels of unmet financial need and is unnecessarily punitive.”

Both the White House and Rep. Dave Camp, the Michigan Republican who is in charge of the House of Representatives Ways and Means Committee, apparently agree. In his fiscal year 2015 budget request, President Obama proposed ending the taxation of Pell Grants, as did Representative Camp in tax reform legislation he introduced in late February.

Such a change would not only help low-income students by reducing their taxes but would also potentially allow them to receive larger tuition tax benefits than they are currently receiving.

As of now, Pell Grants and the American Opportunity Tax Credit often interact in a way that reduces their benefits, particularly for low-income students attending lower-cost institutions, such as community colleges.  Taxpayers can only use the AOTC to cover tuition, fees, and course material expenses. However, if a student receives a Pell Grant, those costs may already be covered, leaving them without the qualified expenses needed to claim the tax credit. As a result, these students may be forced to take out loans or work long hours to cover other necessary expenses, such as room and board, transportation, and child care.

There is a way around this. Taxpayers can pay tuition and fees out of loans or savings, and choose to use the Pell Grant to cover living expenses, which are considered part of the cost of attendance. If they do so, they will have qualified expenses to claim the AOTC. But then, they would be taxed for the whole Pell Grant. “Many families who receive Federal Pell Grants have to choose between paying tax on their Pell Grant and reducing their American Opportunity Tax Credit,” the White House wrote in the president’s budget request.

Denying students and their families the ability to claim a tuition tax credit because they receive Pell Grants is “inappropriate,” the budget documents state. “In nearly all cases, family income for Pell Grant recipients is less than $60,000 and the vast majority of recipients have family income under $30,000.” Under the White House plan, students and their families would be able to use their Pell Grants to cover living expenses without fear of negative tax consequences. As a result, the proposal would “ensure that the tax benefits that a student receives are not reduced by the Pell Grant,” the budget request says.

Both the consortium’s plan and Representative Camp’s proposals would go even further. They would both explicitly state that Pell Grants should be applied first against expenses not covered by the AOTC. “Coordinating grant aid with AOTC would mean students could use the tax credit to cover tuition, fees, and books and use Pell Grants to cover remaining necessary costs,” our consortium wrote.

At a time when it seems nearly impossible to get the White House and House Republicans to agree on anything, it’s encouraging to see they are on the same page about eliminating the taxation of Pell Grants. Low-income students and families can only hope that this is a rare case where good policy trumps politics.