Margot L. Crandall-Hollick Analyst in Public Finance
the face of the rising cost of higher education, families may consider a
variety of ways to finance their children’s college expenses. In order to
make higher education more affordable, Congress has enacted legislation
that provides favorable tax treatment for college savings. Among their
options, families may choose to use a Coverdell education savings account (ESA)
to save for their child’s elementary, secondary, or college education
A Coverdell ESA—often referred to simply as a Coverdell—is a tax-advantaged
investment account that can be used to pay for both higher-education
expenses and elementary and secondary school expenses. The specific tax
advantage of a Coverdell is that distributions (i.e., withdrawals) from
this account are tax-free, if they are used to pay for qualified education
expenses. If the distribution is used to pay for nonqualified expenses, a
portion of the distribution is taxable and may also be subject to a 10%
Several parameters of Coverdells were temporarily modified by the Economic
Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16) and
were most recently scheduled to expire at the end of 2012. At the end of
2012, these modifications were made permanent by the American Taxpayer
Relief Act of 2012 (P.L. 112-240; ATRA).
Two of these EGTRRA modifications which have received recent attention include
an increase in the annual contribution limits and an expansion of the
definition of qualified expenses. Specifically, EGTRRA increased the
annual contribution limit from $500 to $2,000 per beneficiary and allowed
elementary and secondary expenses to be considered qualified education expenses.
Under current law, these changes are now permanent.
This report provides an overview of the mechanics of Coverdells and examines
the specific tax advantages of these plans. Specifically, this report is
structured to first review the major parameters of Coverdells and second,
examine the income and gift tax treatment of Coverdells, using a stylized
example to illustrate key concepts. The report also examines the tax treatment
of rollovers and the interaction of Coverdells with other education tax
benefits. Finally, the report looks at how Coverdells affect a student’s
eligibility for federal need-based student aid.
Date of Report: January 16, 2013
Number of Pages: 13 Order Number: R42809 Price: $29.95
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