COLLEGE SAVINGS 101

Savingforcollege.com

How to calculate your state tax benefit
http://www.savingforcollege.com/articles/how-to-calculate-your-state-tax-benefit-1015

Posted: 2016-12-20

by Brian Boswell

Financial Professional Content

Taxes are hard. And being asked to determine the value of state tax benefit for an in-state vs. out-of-state plan can be even more challenging. Savingforcollege.com makes it easy with our State Tax Calculator, but sometimes you might want to get your hands dirty, or run your own figures. Here we look at how these calculations are made so that you can replicate or augment those figures for your own research and analysis.

Digging into the weeds

In order to determine the value of a 529 plan state tax deduction the following information is required:

  • The taxable income of the individual or married couple (to determine their federal and state tax brackets)
  • The amount of the investment
  • The amount of the state tax deduction (and any relevant details, such as if it allows a carryforward of excess contributions)

Once you have all the relevant information, you need to determine the tax brackets, both federal and state, for the person(s) in question. Once you have the state tax bracket and the value of the deduction, multiply them for the state tax savings value.

For example: In Oklahoma, the value of a $10,000 deduction for an individual in the 5.00% state tax bracket would be $500. (As an aside, Oklahoma reduced its income tax rate in 2016, which also reduced the value of a deduction. Deductions are more valuable in states with higher income tax rates.)

Next, multiply this value by (1 federal tax bracket) to address unpaid federal tax. Once that is completed, you have the final value of the state tax to the tax filer.

Taking the previous Oklahoma example, you would take that $500 and multiple it by (1 the federal tax bracket), which for a single filer with $100,000 in taxable income would be 28%. This would yield (1 0.28) * $500 = $360, which is the net state tax savings.

Keep in mind that this is only for state tax deductions. Some states offer alternate incentives such as credits, grants, and scholarships for those who contribute to a 529 plan. Credits are far superior to deductions because they reduce the tax liability of the filer dollar-for-dollar, meaning a $1,000 credit would reduce taxes owed by $1,000. Grant and scholarship incentives vary widely by state, and need to be evaluated on an individual basis.

Financial Professional Content

Taxes are hard. And being asked to determine the value of state tax benefit for an in-state vs. out-of-state plan can be even more challenging. Savingforcollege.com makes it easy with our State Tax Calculator, but sometimes you might want to get your hands dirty, or run your own figures. Here we look at how these calculations are made so that you can replicate or augment those figures for your own research and analysis.

Digging into the weeds

In order to determine the value of a 529 plan state tax deduction the following information is required:

  • The taxable income of the individual or married couple (to determine their federal and state tax brackets)
  • The amount of the investment
  • The amount of the state tax deduction (and any relevant details, such as if it allows a carryforward of excess contributions)

Once you have all the relevant information, you need to determine the tax brackets, both federal and state, for the person(s) in question. Once you have the state tax bracket and the value of the deduction, multiply them for the state tax savings value.

For example: In Oklahoma, the value of a $10,000 deduction for an individual in the 5.00% state tax bracket would be $500. (As an aside, Oklahoma reduced its income tax rate in 2016, which also reduced the value of a deduction. Deductions are more valuable in states with higher income tax rates.)

Next, multiply this value by (1 federal tax bracket) to address unpaid federal tax. Once that is completed, you have the final value of the state tax to the tax filer.

Taking the previous Oklahoma example, you would take that $500 and multiple it by (1 the federal tax bracket), which for a single filer with $100,000 in taxable income would be 28%. This would yield (1 0.28) * $500 = $360, which is the net state tax savings.

Keep in mind that this is only for state tax deductions. Some states offer alternate incentives such as credits, grants, and scholarships for those who contribute to a 529 plan. Credits are far superior to deductions because they reduce the tax liability of the filer dollar-for-dollar, meaning a $1,000 credit would reduce taxes owed by $1,000. Grant and scholarship incentives vary widely by state, and need to be evaluated on an individual basis.

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