Making Summer Less Taxing, Part II
Two weeks ago, we discussed how Uncle Sam helps many of us pay for the expenses of caring of our kids during the summer, including potential tax benefits from paying for summer camp.
As mentioned then, many parents are also looking at planning for future college costs, and the tax code has some provisions to help there as well. Today, we want to look at one of those vehicles, the “529 Plan”.
The popularity of 529 plans has grown exponentially over the years. During the first quarter of 2015, 529 plan assets increased 10.1% over the same quarter in 2014, reaching an estimated $231.9 billion nationally. That’s up almost $66 billion in just three years – pretty impressive!
Most states, including Arkansas, sponsor or run their own 529 plan(s) and states have differing tax benefits for their particular plan. In Arkansas, for instance, you can deduct up to $5,000 ($10,000 for married couples) from your adjusted gross income on your state income tax return.
All plans, however, are treated the same at the federal level. Contributions are made after tax (meaning not deductible on your federal return), earnings grow tax-deferred, and distributions are tax-free if used for qualifying higher education expenses.
The following are qualifying higher education expenses for this purpose:
- Tuition and fees as required for enrollment;
- Books, supplies, computers, and other equipment required for enrollment;
- Expenses for special-needs services required by a special-needs beneficiary (which must be incurred in connection with enrollment or attendance at an eligible educational institution);
- Expenses for room and board, but only for students who are enrolled at least half-time. The room and board expense qualifies only to the extent that it is not more than the greater of the following:
- The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
- The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution. You most likely will have to contact the eligible educational institution for qualified room and board costs.
Distributions not used for qualifying higher education expenses will be taxed, at least the earnings that are part of such a distribution will be. The taxable portion of the distribution is taxed at the owner’s ordinary income tax rate plus a 10 percent penalty.
The 10 percent penalty, however, is waived if a distribution is made:
- Due to the death, impending death, or long-term disability of the account’s designated beneficiary;
- After the designated beneficiary receives a tax-free scholarship or fellowship grant, veterans’ educational assistance, employer-provided educational assistance, or any other nontaxable payment (other than a gift or inheritance) received as educational assistance;
- Because the designated beneficiary is attending a US military academy;
- Only because it is included in income because the qualified education expenses were taken into account in determining the American Opportunity or Lifetime Learning credits.
A couple of other perks to note - first, if there is money left over in the 529 plan after one child is through with college, the excess can be transferred to another beneficiary without tax, such as to a sibling, a cousin, a parent, or even to yourself.
Also, there are gift and estate tax benefits that can be obtained by “front loading” a contribution to a 529 plan. Someone, such as a grandparent, can fund up to $70,000 per beneficiary ($140,000 for married couples) without generating a gift tax issue by making an election to spread the contributions for gift tax purposes ratably over 5 years, effectively taking advantage of the $14,000 per year annual gift tax exclusion.
Both the Child and Dependent Care Credit written about previously and the 529 plan rules written about here provide an opportunity for you to lower your tax bill, and in doing so, no doubt enjoy a better summer while you “Profit From It”!
