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Favorable Changes for Taxpayers with Section 529 Plans

02.10.16

Included in the "Protecting Americans from Tax Hikes (PATH) Act of 2015" are favorable changes for taxpayers with Section 529 plans.

Time Sensitive Transition Relief

The PATH Act provides transition relief for qualified education expenses refunded in 2015 prior to December 18, 2015 (the enactment date of the PATH Act). Qualified educational expenses refunded in 2015 prior to December 18, 2015 and recontributed to the beneficiary's 529 plan account on or before February 16, 2016 are not treated as 2015 distributions from the beneficiary's 529 plan. Refunds issued on or after December 18, 2015 are subject to the new 60 day deadline for recontribution to the beneficiary's 529 plan (see below).

Background

Section 529 plans, or qualified tuition programs, are college savings accounts established on behalf of a designated beneficiary. Distributions of contributions and earnings from 529 plans are tax-free if the proceeds are used to pay for qualified higher education expenses, such as college or graduate school tuition, room and board, books, and other qualified expenses. If 529 plan distributions during a calendar year exceed the plan beneficiary's calendar year qualified expenses, and there are earnings in the 529 plan, the earnings component of the excess distribution is subject to regular income tax and an additional "penalty" tax of 10% (2.5% for California). Any excess distribution subject to tax is taxable to the owner of the beneficiary's 529 plan.

New Law

Under the PATH Act revisions, refunds of qualified education expenses can be recontributed to the beneficiary's 529 plan in the amount equal to the lesser of: (1) year-to-date 529 plan distributions or (2) the refunds received. The ability to recontribute refunds received into a beneficiary's 529 plan provides a means of avoiding the situation in which the annual 529 plan distributions exceed the beneficiary's qualified education expenses (and thereby possibly subjecting the excess distributions to tax). Under the new law, refunds of qualified education expenses must be received directly from the college or other eligible education institution and recontributed to the beneficiary's 529 plan within 60 days of the refund.

California residents should note that California does not currently conform to this new federal provision allowing 529 plan recontributions of refunds received to be excluded from 529 distributions.

The PATH Act contains other changes to 529 college savings plans that will be addressed in a subsequent alert. If you have any questions regarding this new rule or 529 plans in general, contact your BPM Tax Advisor, call (415) 421-5757, or email bpm@bpmcpa.com.