KY Policy Blog

Growing Tuition Tax Credit Denies Students in Poverty Even As Need-Based College Aid is Underfunded

By Ashley Spalding
May 21, 2014

Kentucky’s recently released biennial tax expenditure report, which documents state spending through provisions in the tax code, shows a growing amount of money going to a program called the Postsecondary Education Tuition Tax Credit. This may seem like a positive trend that could increase college affordability for more Kentuckians in the context of rising tuition. But eligibility requirements for the credit that exclude people below the poverty line mean the program may just worsen inequality in access to higher education, especially combined with the underfunding of state need-based financial aid.

Kentucky’s Postsecondary Education Tuition Tax Credit is a nonrefundable credit against individual income taxes created in 2005. Because it is nonrefundable, those whose incomes are too low to owe income taxes—which in Kentucky since 2005 is anyone below the poverty line—cannot benefit from this form of financial aid. At the same time the poor are denied help from this program, families with incomes in the six figures can benefit.

The credit can be claimed for undergraduate tuition and related expenses—for the person submitting his/her income tax return, his/her spouse, or a dependent—at eligible Kentucky educational institutions. When established, the credit was set at 25 percent of the amount recorded on the federal return for the Lifetime Learning Credit (LLC), which provides up to a $2,000 credit for qualified expenses paid for each eligible student, and the Hope Credit, which is not currently available. Any unused credit can be carried forward five years.

Beginning in 2009, at the federal level the Hope Credit was replaced by the American Opportunity Tax Credit (AOTC), a partially refundable credit that offers up to $2,500 per student for qualified expenses. However, those who claim the AOTC have not qualified for Kentucky’s Postsecondary Education Tuition Tax Credit because the state’s tax code has been tied to the federal code as it was on December 31, 2006 (before the AOTC replaced the Hope credit).

This will change for tax return filers in 2014 as House Bill 445, which was recently signed into law, moves the state’s reference date for the federal tax code to December 31, 2013. This means that for state individual income taxes in 2014, the Postsecondary Tuition Tax Credit will be based on both the LLC and the AOTC.

To qualify for the LLC, an individual’s income can be up to $63,000 and up to $127,000 for a married couple filing jointly. To qualify for the AOTC, an individual’s income can be up to $90,000 (income phase-outs occur between $80,000 and $90,000) or a married couple filing jointly’s income can be up to $180,000 (with income phase-outs occurring between $160,000 and $180,000).

Even though the AOTC is partially refundable at the federal level, the state’s credit is still not refundable. Because Kentuckians below the poverty line don’t pay income taxes since a law passed in 2005 (though they do pay a higher share of their incomes in sales taxes than better-off Kentuckians), they cannot benefit from the credit even while those with incomes well over $100,000 can.

According to the tax expenditure report, the Postsecondary Education Tuition Tax Credit is expected to cost an estimated $20.8 million in 2016, compared to $14.8 million in 2012—an increase of 41 percent over that time period.

While Kentucky is investing a growing amount in this tuition tax credit, support for the state’s need-based financial aid programs has largely been flat in recent years. Although the 2014-2016 state budget includes a small increase for both the need-based College Access Program (CAP) and the Kentucky Tuition Grant (KTG), this bump is tiny—especially in light of how incredibly underfunded these programs are. For instance, CAP can only support a third of the students who qualify for the scholarship—leaving over 76,000 empty-handed in 2012-2013.

Research has shown that need-based financial aid is associated with an increase in college enrollment among low- and moderate-income students as well as an increase in college persistence and the number of credits earned. In contrast, tuition tax credits have not been shown to effectively influence decisions to attend college. This is in part because of the delay in benefiting from education tax credits, which are applied for and received long after students enroll, and also because this form of financial aid typically benefits higher income students who would attend college even without scholarships or tax credits.

Given the dramatic and ongoing increases in tuition at Kentucky’s public universities and community colleges, low-income students face many financial barriers to attending and persisting in college. One small strategy for supporting these students and prioritizing need-based financial aid would be to eliminate the state’s Postsecondary Education Tuition Tax Credit and redirect these funds to need-based aid programs like CAP, a recommendation that has been made by Kentucky’s Higher Education Work Group.

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