As Go the Bush Tax Cuts, So Go Coverdell ESAs

Dennis Zuehlke, Compliance Manager, Ascensusby: Dennis Zuehlke, Compliance Manager, Ascensus

Congress has returned from its five-week August recess to face a slew of deadlines against the backdrop of a presidential election campaign. They are on track to pass a temporary spending bill by September 30 to prevent a government shutdown, but are not expected to address key tax and spending cuts—including an extension of the Bush tax cuts—before the November election. And, as go the Bush tax cuts, so go the current Coverdell education savings account (ESA) provisions.

Without congressional action, the Bush tax cuts will sunset at the end of this year. Much of the debate in Washington is focused on whether to extend the tax rates for all Americans; major changes to ESAs that would see contribution limits lowered and qualified education expenses limited, are basically being ignored.

The Economic Growth and Tax Relief Reconciliation Act (EGTRRA) enacted these tax rates in 2001, along with increasing the IRA contribution limits and indexing them for inflation, enhancing pension plan portability, and making changes to ESAs, then called education IRAs. But EGTRRA was not without controversy, and on the eve of enactment, its passage was threatened by the Byrd Rule, which allows a Senator to block a piece of legislation if it would significantly increase the federal deficit beyond a ten-year period. To sidestep the Byrd Rule and comply with the Congressional Budget Act, a sunset provision was included in the bill, whereby EGTRRA would sunset after December 31, 2010, and we would revert to the pre-EGTRRA state of the law.

Almost immediately after passage, efforts began to make the EGTRRA tax rates permanent. The Pension Protection Act of 2006 made permanent the IRA and pension provisions of EGTRRA, but the tax rates and the enhancements to ESAs were not made permanent. In late 2010, the lame duck Congress passed The Tax Relief, Unemployment Insurance Reauthorization and Job Creation Act of 2010, which provided a two-year extension of the tax rates and ESA provisions of EGTRRA. But the extension will expire on December 31, 2012, unless Congress acts to extend it.

If Congress fails to act and EGTRRA sunsets, the following key ESA provisions would be affected.

  • The annual ESA contribution limit would revert to $500 from the current $2,000 limit.
  • The modified adjusted gross income (MAGI) limits for ESA contribution eligibility would be reduced to $150,000−$160,000 for married couples filing jointly, from the current limit of $190,000−$220,000.
  • Prior-year contributions would no longer be allowed and the deadline to remove excess contributions would revert to the pre-EGTRRA deadline.
  • Qualified education expenses would be limited to higher education expenses only. Distributions to pay for elementary and secondary school expenses would no longer be treated as qualified education expenses.
  • Special needs beneficiaries over the age of 18 would no longer be eligible to receive ESA contributions and ESA assets would need to be distributed within 30 days of the beneficiary’s 30th birthday.

The EGTRRA sunset also may affect the ability of corporations and other entities (including tax-exempt organizations) to contribute to ESAs.

Before leaving for their August recess, the House passed legislation to extend the tax rates for all Americans for another year. A week earlier, the Senate defeated a similar bill, choosing instead to pass legislation to extend the tax rates only for those with incomes up to $250,000. The White House has publically stated that the President would veto any bill that extended the tax rates for all Americans. Further action before the election to extend the tax rates and the ESA provisions of EGTRRA is uncertain.

If action does not occur and the ESA provisions sunset, credit unions will have little time to react to the changes, so contingency planning is warranted. The question now is whether Congress will reach a consensus and vote to extend the tax rates and ESA provisions of EGTRRA before they sunset at the end of 2012. If Congress does act, will it be before the election, after the election, or in early 2013 when the 113th Congress is sworn in? The final outcome could affect the future of your ESA program. Stay tuned.

Dennis Zuehlke is Compliance Manager for Ascensus in Middleton, Wisconsin. Mr. Zuehlke provides clients with technical support on tax-advantaged accounts (including individual retirement accounts, health savings accounts, simplified employee pension plans, and Coverdell education savings accounts), and information reporting and tax withholding issues. Mr. Zuehlke is a frequent national speaker on compliance-related issues and retirement savings trends within the financial services industry. Mr. Zuehlke attended Marquette University and graduated from the University of Wisconsin. Prior to joining Ascensus, he held a similar position with the Credit Union National Association.

Ascensus delivers a full range of retirement plan services—including plan administration, plan design and maintenance, consulting, web-based tools and content, software solutions, education and training, forms and documents, and technical resources—to approximately 9,000 financial organizations nationwide.

Dennis Zuehlke

Dennis Zuehlke

Dennis is Compliance Manager for Ascensus. Mr. Zuehlke provides clients with technical support on tax-advantaged accounts (including individual retirement accounts, health savings accounts, simplified employee pension plans, and Coverdell education ... Web: Details