April 28, 2016 – The Protecting Americans from Tax Hikes (PATH) Act of 2015 has relaxed several restrictions on Section 529 accounts — tax-favored college savings plans used by many parents to help pay the costs of their children’s college educations. Here’s the 411 about 529s.
Section 529 Plans Defined
Section 529 plans allow taxpayers to contribute to investment accounts and later withdraw both the contributions and any earnings to pay college expenses. Though account contributions are not deductible on a taxpayer’s federal income-tax return, account distributions (including earnings) are exempt from federal income taxes when used for the account beneficiary’s qualified higher education expenses.
Generally, qualified higher education expenses include tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution, as well as reasonable room and board costs for students who attend at least half-time.
Previously, computer-related purchases were not considered qualified higher education expenses unless they were required for enrollment or attendance. The PATH Act expands the definition of qualified expenses to include purchases of computer equipment, software, and Internet-related services, provided the equipment, software, and services are to be used primarily by the account beneficiary during any of the years he or she is enrolled. However, purchases of computer software designed for sports, games, or hobbies generally will not qualify. The expanded definition is effective for tax years beginning after December 31, 2014.
Generally, if distributions from a Section 529 account exceed qualified higher education expenses, the taxable portion of the excess (the amount representing earnings) is subject to both income taxes and a 10% penalty. The tax law has rules for figuring the taxable portion.
Under the PATH Act, there is no longer any requirement that all 529 accounts for the same beneficiary be combined for purposes of calculating the taxable portion of a nonqualified distribution. Therefore, if a taxpayer has more than one account for the same beneficiary and anticipates taking a distribution exceeding qualified higher education expenses, the taxpayer may want to take the distribution from the account with the least amount of investment earnings.
Finally, the PATH Act provides relief in situations where the educational institution issues a refund of qualified higher education expenses — which may occur if the student drops a class or withdraws. Under the new rules, if the account owner redeposits such funds in the beneficiary’s 529 account within 60 days, the distribution will be nontaxable.
What About New York State’s 529 Program?
Contributions to a New York 529 plan of up to $5,000 per year by an individual, and up to $10,000 per year by a married couple filing jointly, are deductible in computing New York taxable income. Only contributions made by the account owner, or if filing jointly, by the account owner’s spouse, are deductible. Contribution deadline is December 31 postmark.
Other PATH Act blogs
- The PATH Act’s impacts on individuals
- The PATH Act’s impact on business
- The PATH Act: general overview
About the Author
Dopkins Tax Advisory Group
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