Contributing to a Section 529 Plan? Don’t Miss These Tax Savings

By Kevin Kalal, CPA, MBT

If you’re saving for a child’s or grandchild’s college education, a Section 529 college savings plan offers a welcome break: investment income on these state-sponsored accounts is exempt from both federal and state taxes—if it is used for qualifying higher education expenses, of course. Thanks to a Minnesota law that went into effect on Jan. 1, 2017, contributing to a 529 plan has become more advantageous than ever before.

The law, which applies to the 2017 tax year and beyond, was designed to help Minnesota families who make contributions to a 529 plan via one of two ways: 1) a state income tax credit, or 2) a state income tax deduction. It’s worth noting that Minnesota is one of 33 states that passed similar laws in 2017. Here’s a quick look at how you could benefit.

Are you eligible for the 529 tax credit?

The tax credit equals 50 percent of contributions made to a 529 plan, up to a maximum of $500. The credit is nonrefundable, meaning you must have a state income tax liability in order to apply it. Your income must fall below a certain threshold, too, as the maximum credit is phased out at higher levels.

How does the 529 tax deduction work? 

Unlike the 529 tax credit, income limits do not apply to the deduction. Instead, a taxpayer may deduct up to $1,500 ($3,000 for married joint filers) of 529 plan contributions, regardless of the taxpayer’s adjusted gross income. The deduction limit is per household—not per child. It’s also important to note that the value of the deduction depends on your marginal tax rate. In most cases, the credit will provide a greater tax benefit; however, if your income falls in the credit’s phase-out range, the deduction may be more tax-advantageous. If you claim the credit, you cannot claim the deduction.

Did the Tax Cuts and Jobs Act expand 529 plans to include K-12 expenses? 

Per the Tax Cuts and Jobs Act (TCJA), which was signed into law on December 22, 2017, families can now use 529 plans to pay for not only higher education expenses but also for those associated with K-12 education. Unlike cash distributions taken for higher education expenses, distributions for K-12 education must not total more than $10,000 per single beneficiary in any tax year.

Because this change has the potential to decrease income tax revenue, especially in states like Minnesota that offer a 529 credit or deduction, we are monitoring the situation for any state tax legislation developments, and will update you accordingly.

In the meantime, now is a great time to make sure you’re taking advantage of the benefits associated with your 529 plan.

If you have questions about how the credit, deduction, or the TCJA could affect you, we’re here to help. Give your AEM tax advisor a call today.