The Tax Cuts and Jobs Act (“TCJA”), made changes to Internal Revenue Code Section 529. Section 529 created so called “529 Plans” or “qualified tuition plans” for taxpayers to shield growth in college savings from further income taxes. However, the old Section 529 did not allow for private elementary or secondary school expenses to be paid from the 529 Plans.
Under the TCJA changes, up to $10,000 per year can be withdrawn tax-free from § 529 accounts to pay it. Section 11032 of the TCJA, amended Code § 529(c) by adding § 529(c)(7), which permits tax-free distributions from § 529 accounts to pay “expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.” The limit on distributions for this purpose is $10,000 during the taxable year, which applies per student, not per account. Therefore, if a student is a designated beneficiary of more than one § 529 account, the student can receive only $10,000 free of tax for this purpose in a given year regardless of whether the funds are distributed from multiple accounts.
“Elementary or secondary” school means kindergarten through grade 12. Notice 2018-58, 2018-33 I.R.B. 305 (07/30/18). In this notice, the IRS announced that Treasury and the IRS intend to issue proposed regulations regarding § 529 accounts that will provide, pursuant to the 2017 enactment of § 529(c)(7), that (1) tuition in connection with a designated beneficiary’s enrollment or attendance at an elementary or secondary public, private, or religious school constitutes a qualified higher education expense, and therefore amounts can be withdrawn tax-free to pay it, but that such tax-free distributions are limited to a total of $10,000 per year per designated beneficiary, regardless of whether the funds are distributed from multiple § 529 accounts, and (2) the term “elementary or secondary” means kindergarten through grade 12 as determined under state law, which is consistent with the definition set forth in § 530(b)(3)(B) for Coverdell education savings accounts. The notice also provides that the proposed regulations will address the recontribution of refunded qualified higher education expenses, which might occur, for example, if a student drops a class and receives a refund of tuition. Under § 529(c)(3)(D) (enacted by the 2015 PATH Act), the portion of a distribution that is refunded to an individual who is the beneficiary of a § 529 account by an eligible educational institution is not subject to income tax to the extent the refund is recontributed to a § 529 account of which that individual is the beneficiary not later than 60 days after the date of the refund and does not exceed the refunded amount. The proposed regulations will provide that the entire recontributed amount will be treated as principal (rather than earnings), which is a rule of administrative convenience that avoids certain complexities that otherwise would arise under the rules governing rollovers previously set forth in Notice 2018-58, 2018-33 I.R.B. 305 (07/30/18). The notice provides that taxpayers, beneficiaries, and administrators of § 529 accounts can rely on this guidance before the proposed regulations are issued.
As of November 1, 2018, 17 states have not updated their tax codes to reflect the new Federal law. That means for many individuals (given the populations of the states that haven’t updated their tax code), there could be a surprise tax bill at the state level. These TCJA revisions are effective for taxable years beginning after December 31, 2017.
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