New York May Deviate From The New 529 Rules

When the new tax rules were implemented on January 1, 2018, a popular college savings vehicle that goes by the name of a “529 plan” received a boost.  Prior to the new tax rules, 529 plans could only be used to pay for college.  The new tax rules allow account owners to withdraw up to $10,000 per year per child for K – 12 public school, private school, religious school, or homeschooling expenses. These distributions would be considered “qualified” which means distributions are made tax free.

Initially we expected this new benefit to be a huge tax advantage for our clients that have children that attend private school.  They could fully fund a 529 plan up to $10,000 per year, capture a New York State tax deduction for the $10,000 contribution, and then turn around and distribute the $10,000 from the account to make the tuition payment for their kids.

New York May Deviate

States are not required to adhere to the income tax rules set forth by the federal government. In other words, states may choose to adopt the new tax rules set forth by the federal government or they can choose to ignore them.  The new tax laws that went into effect in 2018 will impact states differently.  More specifically, tax payers in states that have both income taxes and high property taxes, like New York and California, may be adversely affected due to the new $10,000 cap on the ability to fully deduct those expenses on their federal tax return.

As of June 30, 2018, New York has yet to provide guidance as to whether or not they will recognize the K -12 distributions from 529 plans as “qualified”.   More than 30 states have already announced that they will adhere to the new federal tax rules.  On the opposite side of that coin, California has announced that they will not adhere to the new 529 tax rules and they will tax distribution made for K – 12 expenses.  Oregon has gone one step further and will not only tax the distributions but they will also recapture state tax deductions taken for distributions made for K – 12 expenses.

Wait & See

If you live in a state like New York that has yet to provide guidance with regard to the new 529 rules, you end up in this wait and see scenario.  There is no way to know which way New York is going to rule on this new federal tax rule.  However, if New York follows the path taken by many of the other states that were adversely affected by the new federal tax rules, they may decide to follow suit and choose to ignore the new 529 tax rules adopted by the federal government.

We also don’t have any guidance as to when NYS will rule on this issue.  They may wait until November or December to issue formal guidance. If that happens, 529 account owners looking to take advantage of the new K – 12 distribution rules will have to be on their toes because distributions from 529 accounts have to happen in the same year that the expense is incurred in order to receive the preferentially tax treatment.

Potential investors of 529 plans may get more favorable tax benefits from 529 plans sponsored by their own state. Consult your tax professional for how 529 tax treatments and account fees would apply to your particular situation. To determine which college saving option is right for you, please consult your tax and accounting advisors. Neither APFS nor its affiliates or financial professionals provide tax, legal or accounting advice. Please carefully consider investment objectives, risks, charges, and expenses before investing. For this and other information about municipal fund securities, please obtain an offering statement and read it carefully before you invest. Investments in 529 college savings plans are neither FDIC insured nor guaranteed and may lose value.

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.

Tax Deductions For College Savings

Did you know that if you are resident of New York State there are tax deductions waiting for you in the form of a college savings account?  As a resident of NYS you are allowed to take a NYS tax deduction for contributions to a NYS 529 Plan up to $5,000 for a single filer or $10,000 for married filing joint.   These limits are hard dollar thresholds so it does not matter how many kids or grandchildren you have. 

529 Accounts

529 accounts are one of the most tax efficient ways to save for college. You receive a state income tax deduction for contributions and all of the earnings are withdrawn tax free if used for a qualified education expense.  These accounts can only be used for a college degree but they can be used toward an associate’s degree, bachelor’s degree, masters, or doctorate.  You can name whoever you want as a beneficiary including yourself.  More commonly, we see parents set these accounts up for their children or grandparents for the grandchildren.

Can they go to college in any state?

If you setup a NYS 529 account, the beneficiary can go to college anywhere in the United States. It’s not limited to just colleges in New York.  As the owner of the account you can change the beneficiary on the account whenever you choose or close the account at your discretion.

What if they don't go to college?

The question we usually get is “what if they don’t go to college?”  If you have a 529 account for a beneficiary that does not end up going to college you have a few choices.  You can change the beneficiary listed on the account to another child or even yourself.  You can also decide to just liquidate the account and receive a check.  If the account is closed and the balance is not used for a qualified college expense then you as the owner receive your contributions back tax and penalty free.  However, you will pay ordinary income tax and a 10% penalty on just the earnings portion of the account.

What if my child receives a scholarship?

There is a special withdrawal exception for scholarship awards. They do not want to penalize you because the beneficiary did well in high school or is a star athlete so they allow you to make a withdrawal from the 529 account equal to the amount of the scholarship. You receive your contributions tax free, you pay ordinary income tax on the earnings, but you avoid the 10% penalty for not using the account toward a qualified college expense.

Don't make this mistake.............

We often see individuals making the mistake of setting up a 529 account in another state because “their advisor told them to do so”.   You are completely missing out on a good size NYS tax deduction because you only get credit for NYS 529 contributions.  A little-known fact is that you can rollover a 529 with another state into a NYS 529 account and that rollover amount will count toward your $5,000 / $10,000 deduction limit for the year.  If a client has $30,000 in a 529 account outside of NYS we typically advise them to roll it over in $10,000 pieces over a three year period to maximize the $10,000 per year NYS tax deduction. 

About Michael……...

Hi, I’m Michael Ruger. I’m the managing partner of Greenbush Financial Group and the creator of the nationally recognized Money Smart Board blog . I created the blog because there are a lot of events in life that require important financial decisions. The goal is to help our readers avoid big financial missteps, discover financial solutions that they were not aware of, and to optimize their financial future.