One of the many items affected by the 2017 Tax Cuts and Jobs Act (TCJA) were 529 education fund plans. This insight will provide a detailed background of the plans, their tax benefits and implications and the resulting updates per the new tax law.
What are 529 plans?
A 529 plan, also known as a qualified tuition plan (QTP), is a tax-advantaged method of building wealth to aid in the payments of future education costs. Earnings attributable to these funds accumulate tax-free and distributions from a 529 plan are not taxable as long as they are used for qualified educational expenses for the designated beneficiary.
529 plan tax implications
There are two basic types of plans: prepaid tuition plans and education savings plans. The two are similar but differ in various ways captured in the chart below:
|Prepaid tuition plans||Education savings plans|
|Contribution deductibility||Contributions are not tax deductible for federal income tax purposes, but may be deductible for the state income tax purposes depending on the particular state laws. For example, New York allows the deduction annually up to $10,000 for married taxpayers filing a joint return (MFJ).|
|Contribution limitations||Contribution limits are set by the state of establishment, but typically cannot exceed the amount necessary to reasonably provide educational support for the beneficiary. For example, New York's 529 plan accepts contributions until the balance for the beneficiary reaches $520,000. However, there can be gift tax consequences, provided in further detail below.|
|Contributions are used to purchase college units or credits, and in some cases room and board, for future enrollment at a college or university that participates in the plan. With tuition costs on the rise, this helps taxpayers lock in today's rates. However, this plan limits you to using the funds for participating schools only.||Contributions are invested and future distributions can be made for tuition, mandatory fees and room and board for higher education institutions. This allows more flexibility for future use of the funds. Updates from the new tax law are provided in further detail below.|
Tax Cuts and Jobs Act impact on 529 plans
With the implementation of the TCJA, distributions from 529 education savings plans up to $10,000 per year can now be used for private kindergarten through 12th grade tuition expenses. The new tax law enhances the incentive for parents to open these plans by providing parents with greater versatility in how to use their growing investment which now allows for distributions to cover tuition for private grade school through high school.
States - benefits and non-conformity
Some states allow an income tax deduction for contributions to 529 plans, typically up to a certain threshold, providing a further tax benefit to invest in 529 plans. However, it should be noted not all states have conformed to the new TCJA provision in which 529 payments can be applied toward K-12 tuition. The below chart captures the current parameters in reference to various states. Please note that many states are still reacting to the TCJA and their conformity to this specific expansion of the use of 529 plan distributions are not yet finalized.
|Allowable deduction||Limitation||Conform to TCJA K-12 payments|
|Illinois||Yes||$10,000 single, $20,000 MFJ||No|
|Minnesota||Yes||$1,500 single, $3,000 MFJ*||No|
|New York||Yes||$5,000 single, $10,000 MFJ||No|
|Pennsylvania||Yes||$15,000 per contribution, $30,000 MFJ||Yes|
|Washington, D.C.||Yes||$4,000 single, $8,000 MFJ||Yes|
|Wisconsin||Yes||$3,200 per beneficiary, $1,600 for MFS or divorced parents of a beneficiary**||Yes|
*Minnesota residents may claim either a tax deduction or a tax credit, depending on their income.
**There are other nuances to the Wisconsin deduction and taxpayers should consult with their advisers.
Gift tax consequences
A Form 709, United States Gift Tax Return, will be a required filing if contributions to a 529 plan exceed the $15,000 exemption per beneficiary in any given year.†
However, there is a special exception in which the donor can front-load the plan for up to five years in one lump sum with no gift tax consequence. For example, instead of contributing $15,000 per year per beneficiary, a lump sum of $75,000 is allowed in year one and treated as if $15,000 was given per year for the next four consecutive years. No further contributions are allowed until the five years lapse, at which time another $75,000 contribution would be allowed and so forth. A Form 709 must be filed to make this five-year election for the initial year of contribution. If no other gifts are made in the four consecutive years, then no further Form 709 filings will be required for those years.
529 plans are tax-beneficial arrangements. These plans help alleviate tuition-related fears in planning early and building wealth efficiently.
†Note: The gift tax annual exclusion was raised to $15,000 for 2018.
529 plans: Questions and answers
An introduction to 529 plans
Explanation of the impact on Illinois tax revenue resulting from the Federal Tax Cuts and Jobs Act
Education savings account recapture tax
New Jersey's gross income tax treatment
529 plan distributions for K-12 expenses
For more information on this topic, or to learn how Baker Tilly tax specialists can help, contact our team.
The information provided here is of a general nature and is not intended to address the specific circumstances of any individual or entity. In specific circumstances, the services of a professional should be sought. Tax information, if any, contained in this communication was not intended or written to be used by any person for the purpose of avoiding penalties, nor should such information be construed as an opinion upon which any person may rely. The intended recipients of this communication and any attachments are not subject to any limitation on the disclosure of the tax treatment or tax structure of any transaction or matter that is the subject of this communication and any attachments.