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COLLEGE SAVINGS 101

Different states, different 529 plan rules

08/06/2007

QUESTION:
Dear Joe,

What states allow you to make tax-deductible contributions to a 529 plan?

-- Pam

ANSWER:
Dear Pam,

I don't mean to question your question, but it seems to me the only state you should be asking about is the one in which you reside. Other states' laws are irrelevant.

If you live in California, for example, and you make contributions to Pennsylvania's 529 plan, the fact that Pennsylvania permits a tax deduction for contributions to a 529 plan does not affect your California state income tax liability. Only Pennsylvania taxpayers stand to benefit. Your use of another state's 529 plan does not cause you to file tax returns in that state.

For the record, however, 31 states and the District of Columbia offer an upfront tax break for contributions to a 529 plan. It's much easier to list the nine states that do NOT offer a deduction (excluding the states that do not impose an income tax): Alabama, Arizona (deduction takes effect in 2008), California, Delaware, Hawaii, Kentucky, Massachusetts, Minnesota and New Jersey.

If you live in a state offering a tax break, here are some of the additional questions you should be asking:

Does my state offer a tax deduction or a tax credit?
Only two states -- Indiana and Vermont -- offer a tax credit in place of a deduction. Indiana's is especially generous, giving you 20 cents off your Indiana tax liability for every dollar you contribute to the Indiana 529 plan. The maximum Indiana credit is $1,000 per individual tax return. Utah offers a credit or a deduction, dependent on which taxing system you elect to use in that state.

Does my state allow the deduction for contributions to out-of-state 529 plans?
Most states allow a deduction only for contributions to the in-state 529 plan. In three states -- Kansas, Maine and Pennsylvania -- taxpayers can claim a deduction for contributions to any state's 529 plan. Arizona becomes the fourth state with deduction "parity" when its new deduction takes effect in 2008.

Is there a cap on the deduction or credit?
Most states impose a limit on the amount of deduction you can claim each year. For example, Michigan's deduction cap is $5,000 per tax return, increased to $10,000 for Michigan taxpayers filing a joint return. In Iowa, the cap is set at $2,595 per beneficiary in 2007 (the cap is increased each year for inflation), so the more beneficiaries you have the more you can deduct. Four states have no annual limit, offering the potential for a six-figure deduction. Those states are Colorado, New Mexico, South Carolina and West Virginia. The state of Virginia has no limit for taxpayers age 70 and over, but limits the deduction to $2,000 per account for those below the age of 70.

If I contribute more than the cap, can I carry forward the excess to next year's state tax return?
In New York and most other states, contributions in excess of the deduction cap cannot be carried forward, in which case you may want to consider spreading your contribution over two or more years to obtain a bigger state tax benefit. The following governments permit excess contributions to be carried forward for a limited number of years: Connecticut, District of Columbia, Maryland, Oklahoma, Oregon and Rhode Island. Ohio and Virginia place no limit on the number of carryover years.

Are there any other restrictions on my ability to deduct the contributions made to my 529 account?
You'll need to understand these restrictions to avoid unpleasant surprises. Several states disallow the deduction for contributions made by individuals who are not the account owner. Some states allow rollovers from other states' 529 plans to be deducted, while others do not. In Maine and North Carolina, deductions are disallowed for taxpayers with incomes above certain limits. In Wisconsin, the deduction is allowed only on contributions to accounts established for eligible family members.

What is the deadline for making the contribution?
Most states have established Dec. 31 as their deadline, but check to see if the deadline in your state refers to the postmark date or to the date of delivery. A small number of states use April 15 of the following year as their deadline.

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