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Proposals to Change Tax Code Could Impact Higher Education Savings

To simplify the tax code, President Barack Obama is proposing a number of changes that would impact tax credits and savings accounts that families use to finance college.

Under the administration's tax plan released last week, families could no longer withdraw money from 529 Plans tax-free. This would roll back the tax advantage that Congress put in place in 2001. Not having to pay capital gains taxes when funds are taken out of the accounts for tuition has been one of their most attractive features. The change to 529 Plans, however, would only apply to new contributions.

The move caught some 529 Plan advocates by surprise and prompted concern about future participation in the state-managed accounts, according to an article in The New York Times last week. Critics note that the plans are most popular among affluent families and a more-targeted tax policy could help students in the most need.

The nonprofit College Savings Foundation last week issued a statement calling for the administration to recall the proposal to alter 529 Plans. Taxing 529 plan earnings as income would have a "chilling effect on contributions by middle-income Americans," to college savings, said Mary Morris, the chairwoman of the foundation in the statement.

Nearly 7 million families have 529 plans and the average account value is about $20,000, according to the CSF's statistics. About 10 percent of 529 plans are owned by families earning less than $50,000 a year.

Obama also would like the American Opportunity Tax Credit (AOTC), which is set to expire in 2017, expand and become permanent. The administration's new plan would allow students who are enrolled less than half time to qualify for the credit and exempt Pell Grants completely from being taxed.

To encourage schools to do more to support low-income students, the new budget calls for the establishment of a College Opportunity and Graduation Bonus program. The $7 billion initiative over 10 years could reward colleges with extra aid depending on the number of Pell Grant recipients who graduate on time. The administration also wants to start a $4 billion competitive grant program to support states that adopt strategies to make college more accessible and affordable for low-income students.

Lawmakers in the Republican-controlled Congress have largely dismissed the president's tax proposals outlined in the State of the Union proposals, leaving the prospect of passage uncertain.

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