As a result of the tax reform of 2017, the application of qualified tuition programs (“529 Plans” has been broadened dramatically. By coupling the federal tax benefits of 529 Plans with existing Maryland tax provisions, Marylanders may be able to use these plans to reduce the cost of private secondary education by roughly $895 per student per year. These benefits can be achieved even if the accounts are not intended for long-term educational investment and are only used to direct payment of upcoming tuition costs.
Prior to the passage of the Tax Cuts and Jobs Act (“the Act”), distributions from 529 Plans were generally only excluded from gross income if they were used to pay “qualified higher education expenses.” “Qualified higher education expenses” only previously included certain tuition, fees, and other costs associated with an “eligible educational institution,” which principally covered post-secondary education. See I.R.C. § 529(e)(3)(A) (definition of “qualified higher education expenses”); I.R.C. § 529(e)(5) (definition of “eligible educational institution”).
As amended by Section 11032 of the Act, starting in 2018, the definition of “qualified higher education expenses” has been expanded to include “expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.” However, unlike distributions for post-secondary educational expenses which have no upper limit, only $10,000 in annual distributions per beneficiary can be directed from a 529 Plan for secondary education without having a tax effect. In sum, taxpayers with children in private or religious schools will be able to pay up to $10,000 in tuition from existing or future 529 Plans.
Aside from the tax-free accumulation of income within accounts, parents, grandparents, and others paying for private school can take advantage of some added tax incentives – even if they only desire to pay upcoming tuition costs and are not investing for future educational expenses. Pursuant to Maryland Annotated Code, Tax-General § 10-208(o), contributions to a 529 Plan administered in Maryland (e.g., the Maryland College Investment Plan) will result in a corresponding deduction to the contributor’s Maryland adjusted gross income – up to $2,500 per taxable year per qualified designated beneficiary. There is no requirement that a contributor holds the funds in an account for a certain time to obtain this tax benefit. For many, this $2,500 deduction is equal to a financial benefit of about $224.
The tax savings can be illustrated in a simple example. On December 31, 2017, a parent living in Howard County could contribute $2,500 to a 529 Plan for the benefit of their child, who is currently attending private high school. This contribution would be deductible on their Maryland tax return in 2017 and could result in a Maryland tax benefit of nearly $224. On January 1, 2018, the parent could then direct the 529 Plan to pay the tuition for their child. The distribution would be tax-free under the new law.
While Maryland law limits the deductible amount to $2,500 per accountholder (contributor) per beneficiary, additional tax benefits can be gained from creating separate accounts. For example, the mother and father of a child could each make contributions to separate accounts for the same named beneficiary and obtain a $5,000 deduction on their joint tax return (or an approximate tax benefit of $448). This approach could be further expanded by opening two additional accounts, initially naming themselves or their spouse as a beneficiary (in order to claim the deduction) and then changing the designated beneficiary to their child prior to distribution. This strategy could be used to obtain a $10,000 deduction (or a tax benefit of about $895) and would effectively reach the upper limits allowed for tax-free distributions under the law, as amended. (So long as the new beneficiary is a “member of the family” of the old beneficiary and the funds are rolled over within 60 days, the distribution is not subject to tax under I.R.C. § 529(c)(3)(C).)
Although there may be small administrative fees associated with setting up 529 accounts or changing designated beneficiaries, these costs will be vastly outweighed by the financial benefit of the state tax deduction. While this analysis is limited to tax benefits available in Maryland, other states may have similar benefits to encourage investment in education. Marylanders should consider consulting a tax professional to determine how this change to federal tax law, and other recent changes to tax laws, may be used to effectively plan for their family’s upcoming educational needs.
* The potential savings of $895 is based upon the potential tax savings resulting from a $10,000 deduction per child. This figure assumes the maximum state tax rate of 5.75% and maximum local tax rate of 3.20% apply.
These descriptions are intended for informational purposes only and should not be taken as legal advice on any particular set of facts or circumstances. Rosenberg Martin Greenberg, LLP is experienced in all aspects of federal and state tax laws, including tax planning, tax audits and appeals, tax litigation, and more. Please contact Brandon N. Mourges at 410.951.1149 or firstname.lastname@example.org or Seth J. Groman at 410.649.1244 or email@example.com for a free consultation.