January 10, 2019
529 Plan State Tax Traps!
By Paul Miloe, CRPS®
In 2017, Congress passed the Tax Cuts and Jobs Act (H.R.1), and it was signed into law in December of that year. As part of this package, changes were made regarding qualified distributions from 529 College Savings Plans. Under the new law, up to $10K in tuition for K-12 education was added as a qualified expense. However, it’s important to note that this change was a federal change and the ability to take the K-12 distributions from a 529 Plan tax-free only applies to taxes filed with the IRS.
Many states had their tax codes set to synch with federal changes and automatically allowed the K-12 expenses to be withdrawn tax-free. In 2018, a handful of states not synched with federal law, passed corresponding legislation to have their state tax laws updated (AR, IA, KE, ME, NC, OH). Unfortunately, the following states continue not to follow federal law: CA, CO, IL, MN, MT, NE, NM, NY, OR, VT.
Using CA as an example, if funds were withdrawn from a 529 Plan reported to a resident of CA, then CA would treat the distribution as a non-qualified expense and assess a 2.5% penalty tax on any earnings withdrawn (principal distributions are not taxed).
Prior to taking a withdrawal from a 529 plan for K-12 expenses, be sure to consult your tax advisor!
Before investing, the investor should consider whether the investor’s or beneficiary’s home state offers any state tax or other benefits available only from that state’s 529 Plan. For a comprehensive review of your personal situation, always consult with a tax or legal advisor. Neither Cetera Advisor Networks LLC nor any of its representatives may give legal or tax advice.