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Don't count on a 529 state tax break for K-12 tuition
http://www.savingforcollege.com/articles/don-t-count-on-a-529-state-tax-break-for-k-12-tuition

Posted: 2018-01-10

by Kathryn Flynn

The recent change in tax code includes a perk for families who pay for private K-12 tuition. Effective January 1, 2018, for the purposes of 529 savings plans, the definition of "qualified higher education expense" has been expanded to include tuition at elementary or secondary schools which means you can now take federal tax-free withdrawals (up to $10,000) to pay for K-12 tuition. But what about the 30+ states who offer additional tax savings for residents who use 529 plans? Will these benefits also apply when distributions are taken to pay for K-12 school?

Prior to the Tax Cuts and Jobs Act, using a 529 plan to pay for elementary or high school would trigger a non-qualified withdrawal, subject to income tax and a 10% penalty on the earnings portion. There are also additional consequences if you previously claimed a state tax deduction. In most states, non-qualified withdrawals are subject to recapture, meaning the principal portion will included in your state taxable income (to the extent of any prior tax deductions), eliminating any state tax benefit.

States that conform with the new tax law

Many state treasurers are currently working with legislation to determine whether or not K-12 tuition will be considered a qualified expense. But some states, including Missouri, Utah and Delaware, have conformed with the federal law. For residents of Missouri and Utah, that means they will be able claim a state tax benefit. Married couples in Missouri can claim a deduction for up to $16,000 of 529 plan contributions per year, and in Utah contributions of up to $3,840 by a married couple per year are eligible for a 5% state tax credit. Delaware doesn't offer a state tax deduction or credit, but qualified distributions from any state's 529 plan are exempt from state tax.

States that do not automatically follow federal law

Other states aren't as quick to adopt the changes, and could face potential state tax revenue losses if they do. Take Illinois, for example. Contributions to an Illinois 529 plan of up to $20,000 per year by a married couple are deductible in computing state income tax. If every eligible family took advantage of this benefit, Illinois could lose about $90 million in state tax revenue, according to Nat Malkus, deputy director of education policy studies at the American Enterprise Institute, in a recent article from the St. Louis Post-Dispatch.

Iowa residents are also waiting on legislation to determine whether or not withdrawals used to pay for K-12 expenses will qualify for favorable state tax treatment. According to State Treasurer Michael Fitzgerald, expanding state 529 plan benefits is expected to cost between $3.7 and $4.5 million. Residents are being advised to consult with a tax advisor before taking a distribution from an Iowa 529 to pay for elementary or secondary school.

But perhaps being forced to wait isn't such a bad thing. 529 plans were designed to help families pay for college, by offering tax-free investment growth and tax-free withdrawals. Because of the magic of compound interest, the longer you hold the funds in your account, the greater the benefit you're likely to see. The total cost (tuition, fees, room and board) of attending a four year public university is currently around $122,000, yet according to Fidelity's 10th Annual College Savings Indicator study, on average, parents with children ages 0-18 reported having only around $41,500 saved for college. If parents are able to use their income to pay for K-12 tuition, it could make sense to save the 529 plan strictly for college expenses.

A note on Coverdell ESAs

If it turns out that you won't get any 529 state tax benefits for K-12 withdrawals, you could also consider using a Coverdell Education Savings Account. The original version of the Tax Cuts and Jobs Act, introduced in early November, proposed eliminating Coverdell ESAs, but the Senate Amendment and the final bill did not include this provision. Although they do come with limitations - $2,000 maximum contribution per beneficiary per year, and only couples who earn less than $220,000 are eligible Coverdell ESAs offer the same federal tax benefits as 529 plans, and they can be used to pay for K-12 or college expenses. And in some cases, they're more flexible than 529 plans. Coverdell ESAs offer self-directed investments, similar to an IRA, and right now have a broader definition of qualified expenses. According to IRS pub. 970, Coverdell ESAs can be used to pay for "Qualified Higher Education Expenses" and/or "Qualified Elementary and Secondary Education Expenses"- which includes K-12 tuition and fees, books supplies and equipment, academic tutoring, special needs services, and, expenses related to enrollment or attendance: room and board, uniforms, transportation and supplementary items and services (including extended day services). However, the language in the Tax Cuts and Jobs Act simply expands the definition of "qualified higher education expenses" to include private K-12 tuition.

We will continue to keep our readers up-to-date with any upcoming changes in regulation related to college savings. In the meantime, please consult with your specific 529 plan regarding the status of K-12 distributions.

The recent change in tax code includes a perk for families who pay for private K-12 tuition. Effective January 1, 2018, for the purposes of 529 savings plans, the definition of "qualified higher education expense" has been expanded to include tuition at elementary or secondary schools which means you can now take federal tax-free withdrawals (up to $10,000) to pay for K-12 tuition. But what about the 30+ states who offer additional tax savings for residents who use 529 plans? Will these benefits also apply when distributions are taken to pay for K-12 school?

Prior to the Tax Cuts and Jobs Act, using a 529 plan to pay for elementary or high school would trigger a non-qualified withdrawal, subject to income tax and a 10% penalty on the earnings portion. There are also additional consequences if you previously claimed a state tax deduction. In most states, non-qualified withdrawals are subject to recapture, meaning the principal portion will included in your state taxable income (to the extent of any prior tax deductions), eliminating any state tax benefit.

States that conform with the new tax law

Many state treasurers are currently working with legislation to determine whether or not K-12 tuition will be considered a qualified expense. But some states, including Missouri, Utah and Delaware, have conformed with the federal law. For residents of Missouri and Utah, that means they will be able claim a state tax benefit. Married couples in Missouri can claim a deduction for up to $16,000 of 529 plan contributions per year, and in Utah contributions of up to $3,840 by a married couple per year are eligible for a 5% state tax credit. Delaware doesn't offer a state tax deduction or credit, but qualified distributions from any state's 529 plan are exempt from state tax.

States that do not automatically follow federal law

Other states aren't as quick to adopt the changes, and could face potential state tax revenue losses if they do. Take Illinois, for example. Contributions to an Illinois 529 plan of up to $20,000 per year by a married couple are deductible in computing state income tax. If every eligible family took advantage of this benefit, Illinois could lose about $90 million in state tax revenue, according to Nat Malkus, deputy director of education policy studies at the American Enterprise Institute, in a recent article from the St. Louis Post-Dispatch.

Iowa residents are also waiting on legislation to determine whether or not withdrawals used to pay for K-12 expenses will qualify for favorable state tax treatment. According to State Treasurer Michael Fitzgerald, expanding state 529 plan benefits is expected to cost between $3.7 and $4.5 million. Residents are being advised to consult with a tax advisor before taking a distribution from an Iowa 529 to pay for elementary or secondary school.

But perhaps being forced to wait isn't such a bad thing. 529 plans were designed to help families pay for college, by offering tax-free investment growth and tax-free withdrawals. Because of the magic of compound interest, the longer you hold the funds in your account, the greater the benefit you're likely to see. The total cost (tuition, fees, room and board) of attending a four year public university is currently around $122,000, yet according to Fidelity's 10th Annual College Savings Indicator study, on average, parents with children ages 0-18 reported having only around $41,500 saved for college. If parents are able to use their income to pay for K-12 tuition, it could make sense to save the 529 plan strictly for college expenses.

A note on Coverdell ESAs

If it turns out that you won't get any 529 state tax benefits for K-12 withdrawals, you could also consider using a Coverdell Education Savings Account. The original version of the Tax Cuts and Jobs Act, introduced in early November, proposed eliminating Coverdell ESAs, but the Senate Amendment and the final bill did not include this provision. Although they do come with limitations - $2,000 maximum contribution per beneficiary per year, and only couples who earn less than $220,000 are eligible Coverdell ESAs offer the same federal tax benefits as 529 plans, and they can be used to pay for K-12 or college expenses. And in some cases, they're more flexible than 529 plans. Coverdell ESAs offer self-directed investments, similar to an IRA, and right now have a broader definition of qualified expenses. According to IRS pub. 970, Coverdell ESAs can be used to pay for "Qualified Higher Education Expenses" and/or "Qualified Elementary and Secondary Education Expenses"- which includes K-12 tuition and fees, books supplies and equipment, academic tutoring, special needs services, and, expenses related to enrollment or attendance: room and board, uniforms, transportation and supplementary items and services (including extended day services). However, the language in the Tax Cuts and Jobs Act simply expands the definition of "qualified higher education expenses" to include private K-12 tuition.

We will continue to keep our readers up-to-date with any upcoming changes in regulation related to college savings. In the meantime, please consult with your specific 529 plan regarding the status of K-12 distributions.

 

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