J. Michael Smith, Esq.
Michael P. Farris, Esq.
Homeschools and Education Savings Accounts
William A. Estrada, Esq.
Director of Federal Relations
March 19, 2010
Numerous homeschool families have sought to open Education Savings Accounts (ESA) for their children. The U.S. tax code has some provisions to help parents save money to spend on education for their children and to save money tax free for their children’s college education.
Unfortunately, there is still discrimination against homeschoolers in the tax code in this area. HSLDA has long sought to resolve this situation so that all ESAs are open to homeschoolers.
While this article should not be construed as tax advice, we hope that it will help homeschool families to better understand the ESA options that are available to homeschoolers. We strongly recommend that you talk to your tax or financial advisor before you set up an ESA.
The Two Types of Education Savings Accounts
There are two main types of ESAs: the Coverdell ESA, and the newer 529 college savings account. There are benefits to each as well as a few negatives. They both operate under the same principle as the Roth IRA, or other forms of retirement savings accounts. The difference is that ESAs allow parents to save for their children’s education costs. Because the money is placed into the ESA after taxes, all savings are tax free. Contributions (deposits) to ESA’s and interest earned accumulate tax free, and distributions (withdrawals) are also tax free, so long as the money is used for eligible education expenses.
One main difference between the Coverdell and the 529 is that the Coverdell can be used for education expenses anywhere from preschool to graduation from high school, as well as for a child’s college costs. The 529 can only be used for college and graduate school expenses.
Another difference is that families can contribute far more money into a 529 than into a Coverdell. Additionally, the Coverdell has income restrictions on who can contribute. Families who make above a certain level cannot use the Coverdell. The 529 has no such restrictions, making the 529 the vehicle of choice for higher income families.
The Problem with the Coverdell for Homeschool Families
The problem that has faced homeschoolers is that the federal law that created the Coverdell defined eligible expenses as costs associated only with public and private school costs. So the Coverdell cannot be used for homeschool expenses, unless a family is operating their homeschool program as a private school in one of the 14 states where a homeschool is treated as a private school.
Homeschoolers in the other 36 states, therefore, cannot use a Coverdell, unless they are using it solely for college costs.
HSLDA’s Federal Relations Department has been trying to fix this ever since Congress created the Coverdell. The language we have proposed to Congress reads as follows:
(a) In General—Paragraph (4) of section 530(b) of the Internal Revenue Code of 1986 (relating to qualified elementary and secondary education expenses) is amended by adding at the end the following new subparagraph:
(C) SPECIAL RULE FOR HOME SCHOOLS—For purposes of clauses (i) and (iii) of subparagraph (A), the terms “public, private, or religious school” and “school” shall include any home school which provides elementary or secondary education if such school is treated as a home school or private school under State law.
(b) Effective Date—The amendment made by subsection (a) shall apply to taxable years beginning after the date of the enactment of this Act.
Numerous bills including our language have been introduced; none has yet passed Congress.
We will continue to keep our members updated as we work with Congress to revise the Coverdell so that home educators in all 50 states can use these unique education savings accounts. We urge Congress to adopt the language above to eliminate this discrimination against homeschool families. In the meantime, all homeschoolers can use the 529 to save for college. We also encourage you to talk to your tax or financial advisor to see if there are any additional options available to you. Congress may also make changes to ESAs, so you will want to find out if there have been any changes, or if there is another vehicle available to you, from a qualified professional.
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