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529 Plans and Your Tax Return
Thursday, March 12, 2015
While 529 plans are relatively low-maintenance savings vehicles, there are times when account activity will need to be included on your tax return. Here are some things you might need to do this tax season if your family has a college savings plan:
1. Sit back and relax
If you’ve simply been contributing to an existing 529 account you may not have to report anything on your tax return. Unlike an IRA, contributions to a 529 plan are not deductible and therefore do not have to be reported. What’s more, the investment earnings in your account are not reportable until the year they are withdrawn. Yet perhaps you did take a distribution last year and received a Form 1099-Q from the plan - does this mean you have to report the earnings? It depends on what the withdrawal was used to pay for. If the funds were spent on qualified education expenses or rolled into another 529 plan you don’t have to report anything. However, 529 funds spent on purchases that do not fall into one of these two categories will be considered taxable withdrawals.
2. Report any taxable withdrawals
Qualified education expenses include tuition, fees, books, supplies and equipment and some room and board costs. 529 withdrawals spent on other purchases, such as transportation costs or computers if they are not required for course enrollment, are considered non-qualified. If you made non-qualified purchases last year, you will need to review your 1099-Q, which breaks out the basis portion and the earning portion. The earnings portion of a non-qualified withdrawal will be subject to income tax and a 10% penalty. The basis portion will never be taxed or subject to penalty because it is made up with the amount you originally contributed with after-tax money.
3. Report contributions above $14,000
529 contributions up to $14,000 for individuals or $28,000 for married couples filing jointly will qualify for the annual federal gift tax exclusion. Sometimes, for estate planning purposes or other reasons, families will make contributions that exceed this amount. When that happens, you are able to take an election on your gift tax return to spread your contribution over five years. This will allow you to make contributions up to $70,000 ($140,000 for married couples filing jointly) without generating a taxable gift.
4. Report contributions on your state income tax return
If you use a 529 plan and pay state income tax, you may be eligible for an additional benefit. Currently, 34 states including the District of Columbia offer a full or partial tax credit or deduction on 529 plan contributions. Most states only offer this benefit to residents who use their home state’s plan, but residents of Arizona, Kansas, Maine, Missouri, Montana and Pennsylvania offer taxpayers a deduction when they contribute to any state’s plan. Contributions generally
5. Use your refund wisely
If you’re expecting a tax refund check this year, it can be tempting to take a lavish vacation or go on a spending spree. Or, let’s face it - we can easily waste a good amount of money entertaining our little ones. But before you plan an impromptu trip to a theme park or buy front row tickets to Frozen on Ice, consider giving your refund a chance to grow by depositing it into a 529 account. An upfront lump sum contribution is more likely to benefit from potential market gains over the long-term than smaller recurring contributions. But why stop there? We encourage you to deposit your tax refund and continue to keep on saving throughout the year. Many 529 plans offer affordable monthly contribution limits as low as $25 that can be automatically deposited straight from your checking account.
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