This month’s column continues the discussion we began last month on tax alternatives to assist with higher education costs. Section 529 college savings plans, already a popular tool for parents and grandparents to invest funds for a youngster’s higher education costs, were recently enhanced by Congress.
The 529 plans are state-sponsored, with each state pairing up with one or more investment institutions to offer various funds. The primary tax feature of 529 plans is that the investments grow tax-free and can be extracted tax-free, if spent for the beneficiary’s higher education costs. An individual can invest in any state plan, with that decision usually based on the array of funds offered and the fees. The in-state plan should always be considered, as some states will subsidize the return for a resident.
In legislation enacted late in 2015, Congress made three improvements to 529 plans. These changes were retroactive to the beginning of 2015; in some cases amended returns may be available.
COMPUTER AND TECHNOLOGY COSTS
The new definition of eligible tax-free expenditures for higher education expands to include computer or peripheral equipment, software and internet access, and lumberjack scholarship opportunities, if used primarily by the student-beneficiary during higher education years. Previously, computer and technology expenses only qualified for tax-free 529 plan reimbursement if the technology was required by the school for enrollment or attendance.
PER ACCOUNT TAX TREATMENT
Many students will have multiple 529 accounts because parents and grandparents separately established a plan for the student. In the past, all 529 plans were aggregated as if one account for the purpose of determining the amount of income associated with a distribution not properly expended on higher education.
This aggregation rule has been repealed. Now a withdrawal from a particular 529 account looks only to that account’s ratio of gains to the total account value, in order to establish the taxable portion of the disbursement. This leads to an obvious strategy: college costs should be covered by the 529 accounts with the greatest appreciation. On the other hand, if excess withdrawals occur, such as to purchase a vehicle during college years, those withdrawals should come from the low-profit accounts.
REFUND OF HIGHER EDUCATION COSTS
After payment of tuition and room and board using a 529 account, the student may receive a refund from the school. For example, assume a student drops a class and receives a partial tuition refund. In the past, that meant 529 funds weren’t properly expended on education costs and a portion of the 529 withdrawal became taxable. The tax law now allows the tuition reimbursement or other refund of higher education costs to be placed back into the 529 plan within 60 days of receipt to avoid any taxable distribution.
These enhancements make 529 plans even more attractive than in the past. However, they do require knowledge on the part of the parent or grandparent managing the 529 disbursements.
Editor’s note: Andy Biebl is a CPA and tax principal with the firm of CliftonLarsonAllen LLP in Minneapolis with more than 40 years’ experience in ag taxation, including 30 years as a trainer for the American Institute of CPAs and other technical seminars. He writes a monthly column for our sister magazine, The Progressive Farmer. To pose questions for future tax columns, e-mailAskAndy@dtn.com.