State Tax Breaks for 529 Plan Student Loan Repayments

January 3, 2020

Families may now use a 529 plan to repay student loans and pay for registered apprenticeship programs. Money invested in a 529 plan grows on a tax-deferred basis and qualified distributions are tax-free. Many states also offer a state income tax break for 529 plan contributions, however, not all states conform to the current federal definition of qualified higher education expenses.

Changes to the federal tax code

Also known as “qualified tuition programs”, 529 plans are tax-advantaged savings vehicles authorized by Section 529 of the Internal Revenue Code. Since 2015, there were three changes to the federal tax code that expanded the definition of qualified higher education expenses for 529 plans:

In 2015, the Protecting Americans from Tax Hikes (PATH) Act made computers, internet access and related software qualified 529 plan expenses.
In 2017, the Tax Cuts and Jobs Act made K-12 tuition expenses a qualified 529 plan expense (limited to $10,000 per beneficiary, per year).
In 2019, the Setting Every Community Up for Retirement Enhancement (SECURE) Act made student loan payments and costs of apprenticeship programs qualified 529 plan expenses. This applies to 529 plan distributions made after December 31, 2018.

Some states did not automatically conform to the federal definition of qualified higher education expenses that came into effect with the Tax Cuts and Jobs Act. In these states, 529 plan distributions to pay for K-12 tuition are considered non-qualified at the state level. The earnings portion of a non-qualified 529 plan distribution is subject to state income tax, and any state income tax breaks claimed may be recaptured. California also imposes a 2.5% state penalty tax on the earnings portion of non-qualified distributions.

However, in some states legislation was introduced to allow or exclude K-12 tuition as a qualified 529 plan expense. For example, Arizona’s state policy did not automatically conform to the new federal definition of qualified higher education expenses. But, in May 2019, the state passed Senate Bill 1349 to include K-12 tuition as a qualified expense. Oregon’s state policy did conform with the Tax Cuts and Jobs Act, but the state passed House Bill 4080, which excludes K-12 tuition as a qualified 529 plan expense, in June 2018.

Student loan payments and 529 plan state income tax breaks

Under the SECURE Act, 529 plan distributions used to repay student loans are excluded from federal income tax. Qualified distributions are limited to $10,000 over a lifetime for a 529 plan beneficiary and $10,000 for each of the beneficiary’s siblings. The portion of student loan interest that is paid for with tax-free 529 plan earnings is not eligible for the student loan interest deduction.

Families may also qualify for an additional state income tax benefit when they use a 529 plan to repay student loans. Over 30 states offer a state income tax deduction or income tax credit for 529 plan contributions. State income tax benefits are usually only available to residents who use an in-state 529 plan, but seven states offer a state income tax break for contributions to any 529 plan. Most states limit the amount of annual 529 plan contributions eligible for a state income tax benefit, but contributions are fully deductible in New Mexico, South Carolina, Virginia and West Virginia.

Six states (California, Delaware, Hawaii, Kentucky, New Jersey and North Carolina) do not offer a state income tax deduction or credit, but qualified 529 plan distributions are exempt from state income tax.

With the exception of four states (Michigan, Minnesota, Montana and Wisconsin) there are no requirements to hold funds in a 529 plan account for a specified amount of time to be eligible for a state income tax benefit. Residents can make a contribution, immediately tax a qualified distribution to pay student loans and claim a state income tax deduction or state income tax credit. The tax savings function like a discount on tuition at the 529 plan account owner’s marginal state income tax rate.

But, if the state does not conform to the new federal tax laws, the earnings portion of a 529 plan distribution used to repay student loans is subject to state income taxes, and state income tax benefits previously claimed are subject to recapture.

Ohio’s BlackRock CollegeAdvantage 529 plan issued a supplement to its program description that includes the updated qualified higher education expenses. But, Colorado’s CollegeInvest program announced that student loan repayments are not a qualified higher education expense in Colorado. There is still uncertainty about whether other state’s 529 plans will conform to the recent amendments of Section 529 of the Internal Revenue Code.

The following table lists states that offer a state income tax deduction or state income tax credit for 529 plan contributions, whether or not the state definition of qualified higher education expenses (QHEE) is based on Section 529 of the Internal Revenue Code, and if legislation was passed to include or exclude K-12 tuition as a qualified 529 plan expense.

While this list can be a helpful guide, families should check with their state’s rules to confirm student loan repayments are a qualified 529 plan expense at the state level. States that are not listed either do not have income tax or do not offer a state income tax deduction or state income tax credit.

State Definitions of QHEE

State	State definition of QHEE references IRC 529	Legislation Passed to Change State Policy	K-12 tuition is a qualified 529 plan expense
Alabama	Alabama statute only covers expenses at “eligible institutions”, as defined in IRC 529. This does not include K-12 schools.	NO	NO
Arizona	YES	S.B. 1349	YES
Arkansas	YES	S.B. 6	YES
Colorado	Colorado statute covers qualified state tuition programs as defined in IRC section 529 (b), and qualified higher education expenses as defined in IRC section 529 (e) (3), which does not include K-12 tuition expenses	NO	NO
Connecticut	YES	NO	YES
District of Columbia	YES	NO	YES
Georgia	YES	NO	YES
Idaho	YES	H.B. 463	YES
Illinois	NO	NO	NO
Indiana	YES	H.B. 1316	YES
Iowa	YES	S.F. 2417	YES
Kansas	YES	NO	YES
Louisiana	NO	H.B. 650	Launched START K12 Plan
Maryland	YES	NO	YES
Massachusetts	YES	NO	YES
Michigan	Policy is under review, per Michigan’s governor	NO	NO
Minnesota	Minnesota statute covers qualified higher education expenses as defined in section 529 (e)(3), which does not include K-12 tuition expenses	NO	NO
Mississippi	YES	NO	YES
Missouri	YES	S.B. 882	YES
Montana	The “Montana Family Education Savings Act” states that 529 plan withdrawals must be used to pay for postsecondary education expenses	NO	NO
Nebraska	Nebraska statute limits qualified expenses to higher education	N.E. L.B. 804 (FAILED)	NO
New Mexico	The New Mexico “Education Trust Act” states that qualified higher education expenses must be used for a beneficiary at an “eligible institution of higher education”	H.B. 241 (FAILED)	NO
New York	New York statute defines “eligible educational institution” as an eligible educational institution in section 529 (e)(3) in IRC 529, which does not include K-12 schools	S.B. 7783 (FAILED)	NO
North Dakota	YES	NO	YES
Ohio	YES	S.B. 22	YES
Oklahoma	YES	NO	YES
Oregon	YES	H.B. 4080	NO
Pennsylvania	YES	NO	YES
Rhode Island	YES	NO	YES
South Carolina	YES	NO	YES
Utah	YES	NO	YES
Vermont	NO	H. 2	NO
Virginia	YES	NO	YES
West Virginia	YES	NO	YES
Wisconsin	YES	A.B. 259	YES