This report provides an overview of the mechanics of Coverdells, including a summary of the key parameters of Coverdells. The report also examines the specific tax advantages of these plans. Overview

A Coverdell education savings account (ESA)—often referred to simply as a Coverdell—is a tax-advantaged investment account that can be used to pay for both higher-education expenses and elementary and secondary school expenses. The specific tax advantage of a Coverdell is that distributions (i.e., withdrawals) from this account are tax-free, if they are used to pay for qualified education expenses. If the distribution is used to pay for nonqualified expenses, a portion of the distribution is taxable and may also be subject to a 10% penalty. Modifications of Coverdells Made Permanent by the American Taxpayer Relief Act of 2012

Several parameters of Coverdells were temporarily modified by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16 ) and were initially scheduled to expire at the end of 2010. Subsequently, the American Taxpayer Relief Act of 2012 ( P.L. Two modifications which received recent attention include an increase in the annual contribution limits and an expansion of the definition of qualified expenses. Specifically, EGTRRA increased the annual contribution limit from $500 to $2,000 per beneficiary and allowed elementary and secondary expenses to be considered qualified education expenses. Upon enactment of ATRA, these and other changes were made permanent.
A Coverdell ESA—often referred to simply as a Coverdell—is a tax-advantaged investment account that can be used to pay for both higher-education expenses and elementary and secondary school expenses. The specific tax advantage of a Coverdell is that distributions (i.e., withdrawals) from this account are tax-free, if they are used to pay for qualified education expenses. If the distribution is used to pay for nonqualified expenses, a portion of the distribution is taxable and may also be subject to a 10% penalty.
Several parameters of Coverdells were temporarily modified by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA; P.L. 107-16) and were most recently scheduled to expire at the end of 2012. At the end of 2012, these modifications were made permanent by the American Taxpayer Relief Act of 2012 (P.L. 112-240; ATRA).
Two of these EGTRRA modifications which have received recent attention include an increase in the annual contribution limits and an expansion of the definition of qualified expenses. Specifically, EGTRRA increased the annual contribution limit from $500 to $2,000 per beneficiary and allowed elementary and secondary expenses to be considered qualified education expenses. Under current law, these changes are now permanent.
This report describes the mechanics of Coverdells and examines the specific tax advantages of these plans. Specifically, this report reviews the major parameters of Coverdells and then examines the income and gift tax treatment of Coverdells, using a stylized example to illustrate key concepts. The report also examines the tax treatment of rollovers and the interaction of Coverdells with other education tax benefits. Finally, the report looks at how Coverdells affect a student's eligibility for federal need-based student aid.