Taxation of qualified tuition plan contributions and distributions.

• Author: Young, Patrick L.

In 1996, Congress enacted Sec. 529 to codify the significant federal tax breaks delivered by qualified tuition plans (QTPs). Although the details of these plans can vary widely, they all allow parents and grandparents to set up college accounts for children and grandchildren before they reach college age. Once established, these accounts qualify for favorable federal (and often state) tax benefits. QTPs include both prepaid tuition programs and savings programs.

Contributions

There are no federal income tax consequences to either the contributor to a QTP or the designated beneficiary when contributions are made and while funds remain in the account. (Many states allow residents to claim a state income tax deduction for a limited amount of contributions made to the state QTP.) Contributions to a QTP for the benefit of someone other than the contributor are treated as taxable gifts, eligible for the annual gift tax exclusion. If a contribution exceeds the annual gift tax exclusion, the contributor can elect to spread the contribution over a five-year period (Sec. 529(c) (2)). Thus, gift tax returns may need to be filed, depending on the amount of the QTP contributions. Without the election, made by checking the requisite box on Schedule A of Form 709, United States Gift (and Generation-Skipping Transfer) Tax Return, the contributions to a QTP are considered current-year taxable gifts {Estate of Beyer, T.C. Memo. 2016-183).

Note: There are no adjusted gross income-based phaseout rules for making contributions to QTPs. QTPs are available to high-income taxpayers who are ineligible for many of the other education tax incentives (e.g., the tax-free redemption of U.S. savings bonds, interest deduction for education loans, education credits, and Coverdell education savings accounts (ESAs)). Also, while the designated beneficiary will typically be the contributor's child or grandchild, it can be anyone, including nonfamily members, and contributions can be made regardless of the designated beneficiary's age.

QTPs must take measures to ensure contributions will not exceed the amount needed to finance the designated beneficiary's qualified higher education expenses (Sec. 529(b)(6)). As discussed below, these expenses include tuition, fees, books, supplies, and equipment, including the beneficiary's computer. If the plan so provides, room and board also qualifies (within certain limits).

Prop. Regs. Sec. 1.529-2(0(2) establishes a safe harbor for meeting the excess contribution rule. A plan's contribution maximum is deemed to be acceptable as long as it prohibits total contributions beyond the actuarial estimate of the amount needed to pay tuition, required fees, and room and board expenses for five years of undergraduate enrollment at the most expensive school covered by the program. Thus, each state plan may have a different contribution limit. Per Notice 2001-81, both savings and prepaid...