For those of you who have 529 plans, you may be asking how your contributions to the plan will affect your tax return. While for the most part they’re relatively low-maintenance, there are definitely a few times when your 529 plan could come into play during tax season.
What to Do with Your 1099-Q?
Let’s say you took a distribution in the last tax year and received a 1099-Q from the plan. Are you required to report the earnings on your taxes? The answer here depends. If you used the funds to pay for qualified education expenses, or rolled the funds into a different 529 plan, you are not required to report anything. Alternatively, if the 529 funds went to a non-qualified purchase, it is then a taxable withdrawal.
Qualified education expenses include tuition, school fees, books, technology needed for learning purposes, and some room and board costs. For non-qualified expenses you will be subject to income tax and a 10% penalty.
Maximizing Your Contributions
Though there isn’t really a way to time your contributions to help minimize federal taxes, there are some strategies you can use to get the most from your contributions. 529 contributions are considered gifts for tax purposes, which means you can contribute up to the $14,000 gift tax limit, or $28,000 for married couples filing jointly, for each child with a 529 plan. Should you or your family want to contribute more, you are able to make the election to spread your contribution over five years, for up to $70,000, or $140,000 for married couples filing jointly.
State Income Tax Credits
If you live in a state where you pay state income taxes, you could be eligible for a partial or full tax credit or deduction. Over 30 states offer these credits or deductions for 529 plan contributions. Typically a state will only offer these tax benefits to residents using their home state’s 529 plan but there are a few states that will allow taxpayers to receive a deduction for contributions to any state’s plan.
Coordinating your 529 Expenses and American Opportunity Tax Credit Expenses
If you or a dependent of yours is eligible for the American Opportunity Credit, and you also intend to use money from a 529 to pay for qualified expenses, you’ll need to do some coordinating. It is important to remember that you cannot claim the AOTC, or any other college tax credits, based on expenses you used to calculate the tax free portion of a distribution from a 529 college savings plan.
According to the IRS, for a student or their parents to qualify for the American Opportunity Credit, the student must:
- Be pursuing a degree or recognized education credential
- Be enrolled for at least half of the time in at least one academic period (aka, semester, trimester, quarter, etc.) beginning in the tax year
- Not have completed the first four years of post-secondary education in the tax year
- Not have already claimed the AOTC or Hope credit for more than four tax years
- Not have a felony drug conviction at the end of the tax year
There are also income requirements for the AOTC. For full credit, your modified adjusted gross income must be $80,000 or less for single filers or $160,000 or less for couples married filing jointly.
Here’s an example of how qualifying expenses from a 529 and for the AOTC should be separated – let’s say you take out $10,000 from a 529 plan to pay for qualified education expenses. You cannot then use that same $10,000 to try and claim the American Opportunity Credit.
Your Financial Advisor can Help
Coordinating around the rules of your education tax credits can be tricky, especially if you are not a financial professional. We encourage you to discuss your personal situation with your financial advisor or qualified tax professional.
At Walsh & Associates, education planning is just one of the many areas we cover in your financial life. We are happy to help with any of your 529 planning questions, just give us a call!