PPA '06 makes Sec. 529 tax incentives permanent.

• Author: Cook, Ellen D.
• Position: Pension Protection Act of 2006

Among the provisions included in the Pension Protection Act of 2006 (PPA 06) were amendments to the Code repealing the sunset provisions of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), to the extent they apply to the modifications to Sec. 529 qualified tuition plans (QTPs).Thus, all EGTRRA amendments to Sec. 529 originally set to expire after 2010 have been permanently extended. In addition, new Sec. 529(f) authorizes Treasury to issue regulations to prevent abuse of Sec. 529 plans.

Sec. 529 plans first appeared in the Code in 1990. Tax-free growth of Sec. 529 QTPs was clarified by the Small Business Job Protection Act of 1996; the Taxpayer Relief Act of 1997 declared that donations to such plans are completed gifts from contributors, even though account owners maintain control of the accounts. The EGTRRA made several investment-friendly modifications to the Code, including tax-free withdrawals for qualifying expenses after Dec. 1, 2001, increasing the attractiveness of the plans and resulting in tremendous growth in plan assets (which today total $90 billion). (1) The PPA '06 has given potential investors some security and is expected to re-ignite investments in plans, which had fallen because of the looming possible loss of favorable tax status in 2011.

Overview

Sec. 529 provides income and transfer tax rules that allow taxpayers to prepay higher education tuition costs for beneficiaries or themselves (or make contributions to a savings account), by making transfers to one of two types of QTPs--prepaid tuition plans and college savings accounts. According to Sec. 529(c) (1)(A) and (B), generally, plan distributions are not includible in either the contributor's or the designated beneficiary's income.

Prepaid tuition plans: In a prepaid tuition plan, an account owner contributes cash to a plan account, essentially purchasing tuition credits or credit hours based on then-current tuition rates. The obvious advantage is that tuition is locked in at current rates. When the beneficiary attends a college participating in the program and the tuition credits are used to pay for tuition and other college expenses, the distribution is tax free. If the beneficiary attends a nonparticipating college, the tuition credits may be redeemed for cash and used to pay tuition and other expenses, with the same tax-free consequences.

Both states and eligible individual educational institutions (for tax years after 2003) may offer their own prepaid tuition plans. Most of the older Sec. 529 plans were established this way, and are still favored by some, due to the "tuition guarantee" and immunity to the volatility of the stock market. Many of these plans, however, are restricted to residents of the sponsoring state and cover only undergraduate tuition and fees. According to the Congressional Research Service (CRS), 15 states currently have prepaid plans, accounting for $14 billion in contributions and earnings. (2) While more than half the states offer tax incentives in addition to the Federal ones, in general, contributions must be made to one's own state plans.

The nonprofit Tuition Plan Consortium, organized in 2003, created the Independent 529 Plan, (3) in which more than 240 institutions participate. The advantage is that beneficiaries purchase tuition certificates that may be used at any participating institution; a beneficiary is not locked into attending one particular school. Further, plan account owners pay no administrative fees (they are assumed by the participating schools).

College savings accounts: A college savings account allows account owners to contribute cash to a plan account for a beneficiary, with the contribution invested according to predetermined investment strategies. The value of each beneficiary account is based on the performance of the investment option. According to Sec. 529(e)(3)(A) and Prop. Regs. Sec. 1.529-1(c), distributions are generally tax free if used for broadly defined qualifying higher education expenses (QHEEs), including tuition, fees, books, supplies and equipment required for the designated beneficiary's enrollment or attendance at an eligible institution, regardless of the state in which the contributor or beneficiary lives. Also included are expenses for special-needs services for a special-needs beneficiary and room and board for students enrolled at least half-time.

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