In Notice 2018-58, the Treasury Department and the IRS announced their intent to issue regulations providing guidance on the recent tax law changes affecting Section 529 education savings plans. Three 529 plan changes are addressed, including (1) tax treatment of recontributions of tuition refunds; (2) distributions used for K-12 education; and (3) rollovers to ABLE accounts. The rules outlined in this notice can be relied on until the proposed regulations are issued.
To provide a summary of 529 plans – states may establish these plans for a person to save for a beneficiary’s future education expenses. Contributions to these plans are invested and grow tax-free. Distributions are tax-free if the entire amount is used for qualified education expenses (for example: tuition, fees, books, and supplies). A distribution is allocated as part principal and part earnings. The principal portion is the amount of the funds originally contributed. The earnings portion is the growth from those funds being invested. If any part of a distribution is not used for qualified education expenses, then the earnings portion of that amount will be subject to income tax and a 10% penalty tax.
Recontributions of Tuition Refunds
What happens if a student takes a 529 plan distribution for the tuition expense they intend to incur, but they then end up receiving a refund of that tuition? For example, this could occur when a student receives 529 plan distributions to pay tuition for a college semester but then decides to drop one of the classes, causing the school to issue the student a tuition refund.
Regulations are intended to be issued in accordance with §529(c)(3)(D), which provides that the refund will be treated entirely as non-taxable principal if it is recontributed to the 529 plan within 60 days of being received. Additionally, it is anticipated that the regulations will provide that the recontributed amount does not count against the limit on contributions to the 529 plan for the year, and that the recontribution must be to a plan that is for the same student that received the refund.
Prior to the 2017 Tax Cuts and Jobs Act, 529 plan distributions could only be used for undergraduate and graduate education expenses. The 2017 Tax Cuts and Jobs Act expanded the definition of “qualified education expenses” for 529 plans to include elementary school and secondary school tuition. Distributions used for these specific expenses cannot exceed $10,000 per year.
We are awaiting guidance from states as to whether or not they will conform to the new guidelines for qualified distributions from 529 accounts. If they do not, it may mean that an additional calculation for state tax purposes may be required.
The IRS intends to issue regulations defining the term “elementary or secondary” to mean kindergarten through grade 12, as determined under state law. The purpose of this is for 529 plans and Coverdell education savings accounts to use the same definition. Coverdell education savings accounts are another type of tax-advantaged savings accounts that can be used for qualified education expenses. Some students may receive distributions from both types of accounts. 529 plans and Coverdell education savings accounts using the same definition for “elementary or secondary” will facilitate the allocation of expenses between those two accounts for use in determining if total distributions from the accounts exceed total qualified education expenses for a student.
ABLE Account Rollovers
Distributions from 529 plans are considered tax-free if they are transferred (rolled over) to another 529 plan for the same beneficiary or to a 529 plan for a member of the family within 60 days. The 2017 Tax Cuts and Jobs Act now allows these rollovers to also include ABLE accounts. ABLE accounts are tax-advantaged savings accounts that can be used to pay for qualified disability expenses for a person who is disabled or blind. Amounts rolled over from a 529 plan to an ABLE account count towards the overall limitation on amounts that can be contributed to an ABLE account within a tax year. That limitation is $15,000 for 2018.
The IRS intends to issue regulations on these new ABLE account rollovers. The regulations are expected to provide that the sum of the distribution and all other contributions to the ABLE account for the taxable year, other than contributions of the designated beneficiary’s compensation, must not exceed the annual gift tax exclusion for that taxable year. It is also anticipated that the regulations will provide that the same rules will apply regardless of whether such a 529 plan distribution is rolled over to an ABLE account or instead is transferred by a direct transfer from a 529 plan to an ABLE account.
ABLE account transfers in excess of the limitation would be subject to income tax and the additional 10% penalty tax. Therefore, the anticipated regulations will require a 529 plan to prohibit the direct transfer of any amount that would cause that limit to be exceeded. ABLE accounts are already prohibited from accepting certain contributions that are more than the limitation. It is anticipated that the regulations will provide that, in the case of a direct transfer, any excess contribution that is rejected by the qualified ABLE program and returned to the 529 plan will not be deemed to be a new contribution to the 529 plan.
Lastly, it is anticipated that the regulations will specify that, for purposes of identifying the ABLE accounts permitted to receive such a rollover from a 529 plan, a “member of the family” is defined as a spouse; child or descendant of a child; sibling, halfsibling, or stepsibling; father, mother, or ancestor of either; stepparent; niece or nephew; aunt or uncle; in-law; or the spouse of any of the above. It also includes a first cousin, but not a first cousin’s spouse. However, until those regulations are actually issued, there is no way of knowing for sure.
If you need assistance or further guidance in relation to your 529 Plan please contact us.
Written by: Susan George
Susan George joined Thompson Greenspon as a Tax Senior in the fall of 2017. Prior to joining the firm, she worked as a Tax Accountant in the construction & real estate group at a large regional public accounting firm in Tysons, VA.
Susan is responsible for the preparation and review of Federal and multi-state tax returns for corporations, partnerships, trusts, estates, nonprofit organizations, and individuals. She has substantial experience serving clients in the construction and real estate industries and nonprofit organizations.
Susan holds a Bachelor of Business Administration from James Madison University and graduated in 2013. Following her graduation, she attended George Mason University where she enrolled in the Accounting Certificate program to become a CPA. Susan has been a licensed CPA in Virginia since 2016. She is a member of the American Institute of Certified Public Accountants and the Virginia Society of Certified Public Accountants.
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