A Common-Sense Change for Low-Income Students: Excluding Pell as Taxable Income

By Duy Pham

On July 13, 2016, Representative Mark DeSaulnier (D-CA) introduced HR 5764, a bipartisan bill that would exclude all federal Pell Grant funds from taxable income. Under current law, when students spend their Pell Grants on indirect costs to education—such as transportation, food, or housing—these funds are counted as taxable income, while Pell funds used for direct costs like tuition, fees, and books are not. CLASP supports eliminating the discrepancy between direct and indirect costs to ensure low-income students fully benefit from Pell Grants without affecting their eligibility for other needed supports such as refundable tax credits, housing assistance, Supplemental Nutrition Assistance Program (SNAP), and Medicaid.  

The increase in nontraditional students’ unmet financial need is driven largely by the indirect costs of postsecondary education. On average, community college students incur an estimated $16,833 in education-related expenses annually, but only $3,435 of that amount comes from the direct costs of tuition and fees. Indirect costs are included in student budgets as determined by the college and in the federal definition of the cost of attendance used to determine the total Pell Grant. In essence, taxing Pell funds used for indirect costs is awarding low-income students financial aid through one arm of the federal government and taking it away with another.

Although meant to cover both direct and indirect expenses, Pell Grants alone are insufficient to cover all expenses, contributing to high unmet need and forcing students to borrow more, work more hours, take fewer courses, or drop out altogether. For low-income and nontraditional students, public benefits can be a complement to financial aid and help alleviate the financial burden of postsecondary education. CLASP’s paper, Bolstering Non-Traditional Student Success: A Comprehensive Student Aid System using Financial Aid, Public Benefits, and Refundable Tax Credits, provides an analysis of the interaction between financial aid and public benefit programs. For public benefits such as SNAP, Medicaid, and subsided housing assistance, taxable income is used to determine eligibility for these programs.

Eligibility for refundable tax credits such as the Earned Income Tax Credit (EITC) and the American Opportunity Tax Credit (AOTC) is also based partly on taxable income. Since Pell Grant aid used for indirect costs adds to taxable income, low-income students risk becoming ineligible for these tax credits. For example, Pell Grants allocated to direct costs can potentially reduce a student’s AOTC credit for tuition, fees, and materials, which are the only eligible expenses allowed in the AOTC calculation. This interaction between Pell and the AOTC forces some families to decide whether to use AOTC funds for eligible direct costs and potentially pay taxes on Pell funds used for indirect costs. Passage of HR 5764 can help ensure low-income and nontraditional students have access to a comprehensive set of financial supports for persisting in and completing college.

CLASP previously recommended Congress eliminate this tax penalty in our HEA recommendations and also supports the Pathways to an Affordable Education Act, which includes this provision. Additionally, excluding Pell Grants from gross income is proposed in the President’s 2017 Budget. Ending the taxation of Pell both strengthens and upholds Pell’s mission to support students pursuing postsecondary education.

CLASP looks forward to seeing this legislation move forward as an important step in promising that all students have the financial support to succeed in postsecondary education. The bill has been referred to the House Committee on Ways and Means.