EDUCATION SAVINGS ACCOUNTS - S.B. 599 & H.B. 5653 & 5654: ENROLLED ANALYSIS
Senate Bill 599 (as enrolled) - PUBLIC ACT 161 of 2000
House Bill 5653 (as enrolled) - PUBLIC ACT 162 of 2000
House Bill 5654 (as enrolled) - PUBLIC ACT 163 of 2000
Sponsor: Senator Mike Rogers (S.B. 599)
Representative Gary Woronchak (H.B. 5653)
Representative Scott Shackleton (H.B. 5654)
Senate Committee: Finance
House Committee: Tax Policy
Date Completed: 1-23-01
RATIONALE
Section 529 of the Internal Revenue Code, adopted in 1996, allows a state to establish a qualified state tuition program. Section 529 defines a program as one established and maintained by a state or state agency under which a person may: purchase tuition credits or certificates on behalf of a designated beneficiary that entitle the beneficiary to the waiver or payment of qualified higher education expenses; or make contributions to an account that is established for the purpose of meeting a designated beneficiary's qualified higher education expenses. For purposes of Federal taxation, a qualified program works much like a traditional individual retirement account (IRA). Money contributed to an account established under a qualified program is not taxed at the time it is contributed, and the interest generated by the contributions also is not taxed. When the money is withdrawn it is included in the gross income of the person to whom the distribution is made. In most instances, this will be the student, whose income probably places him or her in a lower tax bracket than the person who originally contributed the money. (Any distributions not used for qualified education expenses, made because of the death of the student, or made for other reasons specified in the Code are subject to tax and penalties.)
The ability to pay for a college education or technical training is a major concern for many parents. A qualified state tuition program offers parents an opportunity to save money toward a child's college expenses, on a weekly, monthly, or other basis, over a number of years, and defer the Federal taxes on contributions and interest. Reportedly, other states have established state tuition programs. It was suggested that Michigan establish a qualified State tuition program to allow people to save for college in this manner and, further, exempt from the State income tax contributions to a program, interest earned on the contributions, and withdrawals for qualified education expenses.
CONTENT
Senate Bill 599 created the Michigan Education Savings Program Act to allow individuals to open one or more education savings accounts to save money for the qualified higher education expenses of one or more designated beneficiaries. The bill provides that contributions to and interest earned on an education savings account are exempt from taxation as provided under the Income Tax Act.
House Bills 5653 and 5654 amended the Income Tax Act to allow a taxpayer to deduct from taxable income contributions up to $5,000 per year ($10,000 for a joint return) to an education savings account; the interest earned on the contributions; and qualified withdrawals from an account. Further, House Bill 5653 specifies that a taxpayer may deduct certain distributions from an IRA if the distributions are used to pay "qualified higher education expenses".
Senate Bill 599 was tie-barred to both House bills; each of the House bills was tie-barred to the Senate bill.
Senate Bill 599
Treasurer/Program Manager
The bill establishes the Michigan Education Savings Program within the Department of Treasury. The purposes, powers, and duties of the program are vested in and must be exercised by the State Treasurer, who must administer the program and be the trustee for its funds. The Treasurer may employ or contract with personnel, and contract for services necessary for the program's administration and the investment of its assets, including managerial, professional, legal, clerical, technical, and administrative personnel or services.
The State Treasurer must solicit proposals from entities to be the "program manager", that is, the entity selected by the Treasurer to act as the manager for the program, to provide the services prescribed in the bill. When selecting a program manager, the Treasurer must give preference to proposals from single entities that propose to provide all of the managerial, professional, legal, clerical, technical, and administrative functions. Further, preference must be given to proposals that demonstrate the most advantageous combination, to both participants and the State, of the following factors:
-- Financial stability.
-- The safety of the investment instrument being offered.
-- The ability of the investment instrument to track the increasing costs of higher education.
-- The ability of the entity to satisfy the record-keeping and reporting requirements of the bill.
-- The entity's plan for marketing the program and the investment it is willing to make to promote the program.
-- The fees, if any, proposed to be charged to persons for opening or maintaining an account.
-- The minimum initial deposit and minimum contributions that the entity will require, which may not be greater than $25 for a cash contribution or $15 per pay period for payroll deduction plans.
-- The ability of the entity to accept electronic withdrawals, including payroll deduction plans.
Management Contract
The Treasurer may enter into contracts that he or she considers necessary and proper for the implementation of the program. A contract executed between the Treasurer and the program manager, the "management contract", must address the factors described above regarding the selection of a program manager. The management contract also must address the respective authority and responsibility of the Treasurer and the program manager to do the following:
-- Develop and implement the program.
-- Invest the money received from account owners in one or more investment instruments.
-- Engage the services of consultants on a contractual basis to provide professional and technical assistance and advice.
-- Determine the use of financial organizations as account depositories and financial managers.
-- Charge, impose, and collect administrative fees and service charges (which may not exceed 1.5% of the average daily net assets of an individual account), in connection with any agreements, contracts, and transactions relating to individual accounts.
-- Develop marketing plans and promotional material.
-- Establish the methods by which funds are allocated to pay for administrative costs.
-- Provide criteria for terminating and not renewing the management contract.
-- Keep adequate records of each account and provide the Treasurer with related information that he or she requires.
-- Compile the information contained in statements required to be prepared under the bill and provide that compilation to the Treasurer in a timely manner.
-- Hold all accounts for the benefit of the "account owner", that is, the individual who enters into a Michigan education savings program agreement and establishes an education savings account.
-- Provide for audits at least annually by a firm of certified public accountants.
-- Ensure that any description of the program, whether in writing or through the use of any media, is consistent with the marketing plan developed by the program manager.
-- Perform any other necessary and proper activities to carry out the purposes of the bill.
The management contract also must address the ability of the program manager to take any action required to keep the program in compliance with the requirements of the bill and the management contract, and to manage the program to qualify as a qualified State tuition program under Section 529 of the Internal Revenue Code.
In addition, the contract must address the program manager's responsibility to provide the Treasurer with copies of all regulatory filings and reports related to the program made during the term of the management contract or while the program manager is holding any accounts, other than confidential filings or reports except to the extent they are related to or part of the program. The program manager is responsible for making available for the Treasurer's review the results of any periodic examination of the manager by any State or Federal banking, insurance, or securities commission, except to the extent that the report or reports are not required to be disclosed under State or Federal law.
The Treasurer is responsible for the ongoing supervision of the management contract in consultation with the board of directors of the Michigan Education Trust (MET). (The Met board, of which the Treasurer is a member, oversees the State's advanced tuition payment program.) The management contract must be for a term of years specified in the contract. The Treasurer may terminate the contract based on the criteria specified in it.
Education Savings Accounts/Distributions
Education savings accounts may be established under the bill beginning October 1, 2000. To open an education savings account, an individual must enter into a savings program agreement with the program manager. The savings program agreement must be in the form prescribed by the program manager and approved by the Treasurer, and contain all of the following: the name, address, and Social Security number or employer identification number of the account owner; a designated beneficiary; the name, address, and Social Security number of the designated beneficiary; and any other information that the Treasurer or program manager considers necessary.
Any individual may make contributions to an account. Contributions must be made in cash or by check, money order, credit card, or similar method but may not be property.
An account owner may withdraw all or part of the balance from an account on 60 days' notice, or a shorter period as authorized in the savings program agreement. Distributions from an account must be used to pay for "qualified higher education expenses" incurred after the account is established. "Qualified higher education expenses" are those expenses as defined in Section 529 of the Internal Revenue Code. (Section 529 states that "qualified higher education expenses" means tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution. The term can include reasonable costs for room and board, incurred by the designated beneficiary while attending the institution, as determined under the qualified state tuition program, and as limited under the Code.)
Distributions from an account may be made only under any of the following circumstances:
-- The distribution is made directly to an "eligible educational institution", i.e., a college, university, community college, or junior college described or established under the State Constitution, or described in the Federal Higher Education Act of 1965.
-- The distribution is made in the form of a check payable to both the designated beneficiary and the eligible educational institution.
-- The distribution is made after the designated beneficiary submits documentation to show that it is a reimbursement for qualified higher education expenses that the designated beneficiary already paid, and the program has a process for reviewing the validity of the documentation prior to the distribution.
-- The designated beneficiary certifies prior to the distribution that it will be spent for his or her qualified higher education expenses within a reasonable time after the distribution is made; the program requires the designated beneficiary to provide documentation of payment of qualified higher education expenses within 30 days after making a distribution, and has a process for reviewing the documentation; and the program retains an account balance that is large enough to collect any penalty owed on the distribution if valid documentation is not produced.
If a distribution that is not a "qualified withdrawal" is made, the program manager must withhold an amount equal to 10% of the distribution amount as a penalty, and pay that amount to the Department of Treasury for deposit into the General Fund. The penalty may be increased or decreased if the Treasurer and the program manager determine that it is necessary to increase or decrease the penalty to constitute a greater than de minimis penalty for purposes of qualifying under Section 529 of the Internal Revenue Code. (Under Section 529, a program cannot be treated as a qualified program unless it imposes a more than de minimis penalty on any refund of earnings from an account that are not used for qualified higher education expenses of the designated beneficiary; made on account of the death or disability of the designated beneficiary; or made on account of a scholarship, allowance, or payment received by the beneficiary to the extent the refund amount does not exceed the amount of the scholarship, allowance, or payment.)
Under the bill, a "qualified withdrawal" is a distribution that is not subject to penalty or taxation under the bill or the Income Tax Act, and that is any of the following:
-- A withdrawal from an account to pay qualified higher education expenses incurred after the account of the designated beneficiary is established.
-- A withdrawal made as the result of the death or disability of the designated beneficiary.
-- A withdrawal made because a beneficiary received a scholarship that paid for all or part of his or her qualified higher education expenses, to the extent the withdrawal does not exceed the amount of the scholarship.
-- A transfer of funds due to termination of the management contract as provided in the bill.
-- A transfer of funds due to a change of beneficiary.
Withdrawals that are not qualified withdrawals made from education savings accounts are taxable as provided in Section 30 of the Income Tax Act (as amended by House Bill 5653).
Account Owners
An account owner may designate another individual as a successor owner of the account in the event of the death of the account owner; change the designated beneficiary of an account to a member of the family of the previously designated beneficiary as provided in the management contract or as otherwise provided in the bill; or transfer all or a portion of an account to another education savings account for a designated beneficiary who is a member of the family. Changes in designated beneficiaries and transfers are not permitted to the extent that a change or transfer would constitute excess contributions or unauthorized investment choices. ("Account owner" means the individual who enters into an education savings program agreement and establishes an education savings account. The account owner also may be the designated beneficiary of the account.)
No account owner or designated beneficiary of any account may direct the investment of any contributions to an account or the earnings on an account. An individual who establishes an account may select among different investment strategies designed exclusively by the program manager, but only at the time the initial contribution that establishes the account is made. The program may allow MET board members or employees of the program, or the board members or employees of a contractor hired by the program to perform administrative services, to make contributions to an account.
Neither an account owner nor a designated beneficiary may use an interest in an account as security for a loan. Any pledge of an interest in an account has no force or effect.
A maximum of $125,000 may be contributed in total to all of the accounts that name any one individual as the designated beneficiary. Any amount in excess of $125,000 is not a qualified withdrawal and must be promptly withdrawn or transferred to another account.
Program Manager Reports
The program manager must report distributions from an account to any individual, or for the benefit of any individual, during a tax year to the Internal Revenue Service and the account owner or, to the extent required by Federal law or regulation, to the distributee. The program manager must give each account owner statements that identify the individual contributions made during a tax year, the total contributions made to the account for the tax year, the value of the account at the end of the tax year, distributions made during the tax year, and any other information that the Treasurer requires, by January 31 following the end of each calendar year.
The program manager also must disclose the following information in writing to each account owner of an education savings account and any other person who requests information about an education savings account:
-- The terms and conditions for establishing an education savings account.
-- Restrictions on the substitutions of designated beneficiaries and transfer of account funds.
-- The person or entity entitled to terminate an education savings program agreement.
-- The period of time during which a designated beneficiary may receive benefits under the agreement.
-- The terms and conditions under which money may be wholly or partially withdrawn from an account or the program, including any reasonable charges, fees, and penalties that may be imposed for withdrawal.
-- The potential tax consequences associated with contributions to, and distributions and withdrawals from, accounts.
-- Investment history and potential growth of account funds and a projection of the impact of the growth of the account funds on the maximum amount allowable in an account.
-- All other rights and obligations under education savings program agreements and any other terms, conditions, and provisions of a contract or an agreement entered into under the bill.
The program manager also must file with the Treasurer and the MET board an annual report that includes the names and identification numbers of account owners, designated beneficiaries, and distributees of family tuition accounts. (This information is not subject to the Freedom of Information Act.) Further, the report must include the total amount contributed to all accounts during the year; all distributions from all accounts, and whether or not each distribution was a qualified withdrawal; and any information that the program manager or Treasurer requires regarding the taxation of amounts contributed to or withdrawn from accounts.
Limitations
The bill provides that the Act, and any agreement under it, may not be construed or interpreted to do any of the following:
-- Give any designated beneficiary any rights or legal interest with respect to an account, unless the beneficiary is the account owner.
-- Guarantee that a designated beneficiary will be admitted to an eligible educational institution or, upon admission, will be permitted to continue to attend or will receive a degree from the eligible educational institution.
-- Give residency status to an individual merely because he or she is a designated beneficiary.
-- Guarantee that amounts contributed to an account will be sufficient to cover the qualified higher education expenses of a designated beneficiary.
The bill specifies that the Act does not create, and may not be construed to create, any obligation upon the State or any agency or instrumentality of the State to guarantee for the benefit of an account owner or designated beneficiary the rate or payment of interest or other return on an account. The contracts, applications, deposit slips, and other similar documents used in connection with a contribution to an account must clearly indicate that the account is not insured by the State, and that money deposited into and investment return earned on an account are not guaranteed by the State.
House Bill 5653
The bill amended the Income Tax Act to allow a taxpayer to deduct, to the extent not deducted in determining the taxpayer's Federal adjusted gross income (AGI), both of the following for tax years beginning after 1999:
-- The total of all contributions made on and after October 1, 2000, by the taxpayer in a tax year to education savings accounts pursuant to the Michigan Education Savings Program Act, not to exceed $5,000 for a single return or $10,000 for a joint return. (A deduction is not allowed for contributions to an education savings account in the tax year in which an initial withdrawal is made from that account, or in any subsequent year.)
-- Interest earned on contributions and qualified withdrawals (as provided under House Bill 5654).
For tax year that begin after 1999, a taxpayer must add to taxable income, to the extent not included in Federal AGI, the amount of money the taxpayer withdraws from an education savings account that is not a qualified withdrawal.
The bill provides that for tax years beginning after 1999, a taxpayer may deduct, to the extent not included in Federal AGI, the amount of a distribution from an IRA if the distribution is used to pay qualified higher education expenses (as defined under Senate Bill 599). This provision applies to standard IRAs (to which contributions are tax exempt and withdrawals are taxed) but not to Roth IRAs (to which contributions are taxed but withdrawals are not taxed).
House Bill 5654
The bill amended the Income Tax Act to provide that for tax years beginning after 1999, a taxpayer may deduct, to the extent not deducted in determining Federal AGI, interest earned in a tax year on contributions to the taxpayer's education savings accounts. Further, a taxpayer may deduct, to the extent included in Federal AGI, distributions that are qualified withdrawals from an education savings account to the designated beneficiary of the account.
MCL 390.1471 et al. (S.B. 599)
206.30 (H.B. 5653)
206.30f (H.B. 5654)
ARGUMENTS
(Please note: The arguments contained in this analysis originate from sources outside the Senate Fiscal Agency. The Senate Fiscal Agency neither supports nor opposes legislation.)
Supporting Argument
Many parents, especially those who have large families, rightfully are concerned about paying the high costs of higher education for their children. The foundation of a successful career often hinges on the ability of an individual to obtain a college degree or some kind of advanced technical training. It is imperative for today's youngsters that parents be given every opportunity, and a range of options, to save for children's advanced education. The Michigan Education Trust program, which allows people to purchase contracts with the State for the future payment of college tuition, has thousands of participants but is limited in that its contracts have fixed costs that many cannot afford. Further, the program covers only the cost of tuition, which is often less than half of the total costs associated with higher education. Many people simply put money in a savings account for future use, but this has no tax advantages and no guarantee that the money will not be used for something else before being used for college expenses. Investing money in growth funds has its advantages, but the owners of an account (parents) often lack investment knowledge, there is no guarantee that the investments will grow and, once again, the money can be diverted to other uses before it is needed for college.
The bills establish an ideal program for people to save money to further the education of their children, or grandchildren for that matter. An education savings account may be opened for a minimal amount, and contributors may dedicate any amount they wish (up to the maximum), at any time. This allows great flexibility, and encourages poor, middle, and upper income citizens to contribute to an account. Once contributed, the money must be used for qualified education expenses, or withdrawals are subject to penalties. This provides a strong incentive to leave contributions in an account to be used for their original purpose. Finally, contributions, interest earned in an account, and withdrawals are exempt from State taxation. Thus, the bills allow parents or other contributors to maximize the full value of their investments, which further encourages the use of such accounts.
Response: Without a limit on the income of people who contribute to an education savings account, the bills favor upper income individuals, who may deposit the most into an account and, consequently, receive the greatest tax break. Furthermore, the $125,000 cap on the amount that may be contributed to a beneficiary's account also favors those who can afford to deposit large sums.
- Legislative Analyst: G. Towne
FISCAL IMPACT
These bills will reduce income tax revenue an estimated $7.7 million in FY 2000-01, and $8.5 million in FY 2001-02. This loss in revenue will reduce General Fund/General Purpose revenue an estimated $7.5 million in FY 2000-01 and $8.3 million in FY 2001-02, and School Aid Fund revenue will be reduced $0.2 million in FY 2000-01 and $0.2 million in FY 2001-02.
These estimates are based on data from other states that have already established education savings accounts.
- Fiscal Analyst: J. WortleyA9900\s599ea
This analysis was prepared by nonpartisan Senate staff for use by the Senate in its deliberations and does not constitute an official statement of legislative intent.