By William L. Stunkel, CPA
In December 2017, with the passage of the Tax Cuts and Jobs Act (tax reform), a new provision was added to the tax code that can benefit many families whose children attend a private school for kindergarten through 12th grade (K-12).
Previously, funds contributed to a 529 education savings plan could be used solely for qualified secondary education expenses. Any use outside of qualified secondary education expenses would cause the earnings on a withdrawal to be subject to income taxes as well as potential penalties.
With the passage of tax reform, those funds can now be used for the payment of tuition for K-12 education.
Many 529 accounts are run by the states, and they each have their own rules. Account owners, beneficiaries, and beneficiaries’ parents should be aware of all the rules that apply to the particular account they are using. Rule differences can be related to maximum contributions and maximum account balances. For example, in Pennsylvania, once the aggregate account balances reach $511,758 for a beneficiary, no more contributions can be made to a PA 529 plan for that individual.
Issues to be aware of when deciding to use funds from a 529 plan for K-12 include the following:
- How much is being withdrawn?
There are no annual limits to the dollar amount of qualified secondary education expenses that can be paid in a given year. However, for qualified K-12 expenses there is a limit of $10,000 per calendar year.
- Are the expenses qualified?
Tuition, room and board, and equipment (such as computers) are some of the secondary education expenses that qualify. However, for K-12 students, only the tuition paid is a qualified expense.
- Does your state tax distributions?
Depending on the state your live in or the state the plan is in, distributions may be subject to state income tax. While tax reform exempted K-12 tuition withdrawals from federal income taxes and penalties, the individual states control whether such withdrawals are exempt from state income tax. Pennsylvania does not tax distributions up to $10,000 that are used for qualified K-12 tuition.
- Are you limiting the 529 benefits available for college by using 529 plan contributions and withdrawals for K-12 tuition?
If a family intends to utilize a 529 plan for both K-12 tuition and saving for future college expenses, they should be cognizant of which funds they liquidate within the plan to pay for the K-12 tuition. The power of saving for college with a 529 plan comes from investment growth over time without tax. If funds currently invested are liquidated to pay for current K-12 tuition costs, make sure the funds remaining within the 529 plan account are still invested. If funds were originally planned for secondary education but are instead used for K-12 tuition, do not neglect making additional contributions when possible to replenish the secondary education savings.
- What is the real benefit to using a 529 plan for K-12 tuition?
If the state you live in allows you a tax deduction for contributions, you may be able to contribute the funds needed for K-12 tuition and withdraw them to pay that tuition in the same year. In Pennsylvania, this type of contribute-and-withdraw strategy would save up to $307 per year per student. Review the rules of the particular state 529 plan as well as the rules for the state you live in, as there may be time limits on when funds are contributed and when they can be withdrawn.
- Are withdrawals from (and contributions to) multiple accounts being made for the same beneficiary?
Most limitations on 529 plans are on a per-beneficiary basis. Thus, if grandparents have a 529 account for a grandchild and parents also have a separate 529 account for the same child, the $10,000 K-12 tuition limit applies across all accounts for that beneficiary. If the K-12 tuition is $15,000 for the child, withdrawals across the accounts cannot exceed the $10,000 limit for that child. The remaining $5,000 of tuition must be paid with funds other than from a 529 plan.
As with all new changes to the tax law, consulting with a qualified adviser such as a CPA can help answer any questions you have and help you ensure you do not run afoul of any of the rules.
William L. Stunkel, CPA, is president of Stunkel Tax & Accounting in Pittsburgh and is a member of PICPA’s CPA Image Enhancement Committee. He can be reached at firstname.lastname@example.org.