Section 529 Plans - Qualified Tuition Program
COLLEGE SAVINGS PLANS THAT THE IRS EMBRACES
By: Beth S. Cohn
As higher education costs continue to escalate, parents or
grandparents may look to different savings vehicles for their
children's college fund. The IRS, under section 529, provides
parents with the opportunity for a higher education savings
plan.
There are two sets of tax rules for 529 plans (the
"Plan"). One relates to the income taxation of the owner
and the beneficiary of the Plan, while the other relates to
gift tax consequences of making a contribution and/or changing
beneficiaries. It is important to take advantage of contributions,
gain on investments and beneficiary flexibility to enjoy the
maximum benefits from a 529 plan.
Contribution Limits and
Eligibility for Use of Funds
There are no specific contribution limits or age limits for the
use of funds; however, the amount contributed must be used by the
beneficiary for "qualified higher education expenses". The
IRS defines qualified expenses to include tuition, books, supplies,
fees and required equipment. Reasonable room and board is also a
qualified expense if the student is enrolled at least
half-time. Eligible schools include colleges, universities,
vocational schools, or other post-secondary schools eligible to
participate in a student aid program of the Department of
Education. This is a very broad definition and includes nearly all
accredited public, nonprofit, and proprietary (for-profit)
post-secondary institutions. A school knows whether or not it
qualifies and can provide that information to potential
students. To be qualified, the Plan needs to have safeguards
that prevent contributions for a beneficiary in excess of the
amount necessary to fund qualified higher education expenses for
the beneficiary.
Income Tax Consequences
of Contributions and Distributions
Contributions made to a 529 plan are not deductible from income
taxes. However, accrued earnings in the plan are tax
free. Distributions to a beneficiary generally do not have to
be included as gross income to the beneficiary, if the distribution
is less than or equal to qualified higher education
expenses. If there are distributions made in excess of
the amount used by the beneficiary to pay qualified higher
education expenses then those distributions are included in gross
income of the beneficiary. If there are earnings in the
excess distribution, then they are also subject to a 10%
penalty.
Gift tax Consequences of the
Contribution
A contribution to a 529 plan is treated like a gift from the
owner of the Plan to the Beneficiary. The annual gift tax
exclusion applies, which in 2012 is $13,000 per donee per
year. The gift tax exclusion may be adjusted by the IRS
annually. If the amount put in to the 529 Plan exceeds the
annual exclusion for a given year, the excess amount can be
applied against the annual exclusion ratably over 5
years. This functions like a carryover, and an election has
to be made. In any tax year that an amount is carried
over, the total annual exclusion, including the carried over
amount, cannot exceed the annual exclusion limit. If no other
gifts are given to the beneficiary, the total amount that can be
placed into a 529 Plan and qualify for the annual gift tax
exclusion over 5 years is $65,000. The owner will need to
file a gift tax return and use part of their lifetime exemption if
the contributions exceed the annual gift tax exclusion.
Change of
Beneficiaries
In the event that the child (beneficiary) does not use all of
the funds for qualified higher education expenses, then the
beneficiary of the 529 Plan can be
changed. The new beneficiary has to be a family
member of the old beneficiary to avoid adverse tax consequences for
the beneficiary change. This provides much needed
flexibility in the event that the original designated beneficiary
does not attend college or receives a full scholarship.
Another child can be named as long as the child is a member of the
family. If funds remain in the 529 Plan after a
beneficiary has finished school, a younger child can be named
beneficiary of the Plan. There may also be gift
tax consequences on the change of the beneficiary. The IRS
currently defines Members of the beneficiary's
family as follows.
"For these purposes, the
beneficiary's family includes the beneficiary's spouse and the
following other relatives of the beneficiary
1. Son, daughter, stepchild, foster
child, adopted child, or a descendant of any of them.
2. Brother, sister, stepbrother, or
stepsister.
3. Father or mother or ancestor of
either.
4. Stepfather or stepmother.
5. Son or daughter of a brother or
sister.
6. Brother or sister of father or
mother.
7. Son-in-law, daughter-in-law,
father-in-law, mother-in-law, brother-in-law, or sister-in-law.
8. The spouse of any individual
listed above.
9. First cousin."
Source:
http://www.irs.gov/publications/p970/ch08.html#en_US_2011_publink1000178575
This is a general overview of the IRS rules on Section 529
plans. It is not an exhaustive analysis. These
rules are very complicated, and we recommend that you consult a tax
professional before establishing a 529 plan.
About the author: Beth S.
Cohn is a shareholder at the Phoenix law firm of
Jaburg Wilk where she assists clients with business,
tax, gifting programs, succession planning, asset protection and estate planning. She
chairs the business law department and is a State Bar of Arizona
certified tax specialist and a CPA. Beth can be reached at bsc@jaburgwilk.com or
602.248.1030.
IRS CIRCULAR 230 DISCLOSURE: To ensure compliance with
requirements imposed by the IRS, we inform you that, to the extent
this communication addresses any tax matter, it was not written to
be and may not be relied upon to (i) avoid tax-related penalties
under the Internal Revenue Code, or (ii) promote, market or
recommend to another party any transaction or matter addressed
herein.
3200 North Central Avenue
. Phoenix . Arizona