Most States Allow Tax-Free 529 Withdrawals for K-12 Tuition

Most states are following the new federal law that allows 529 plan withdrawals to be used for up to $10,000 per year, per child for K-12 tuition expenses. For these states, the K-12 tuition counts as qualified higher education expenses, so the 529 plan distributions are tax-free.

Over the years, states have generally followed the federal treatment of 529 plan withdrawals. That is, the withdrawals are not subject to state tax when used for qualified expenses. In addition, while there is no federal deduction for contributions, many states offer a state deduction or credit for contributions to 529 plans.

For example, Illinois allows a state tax deduction for 529 plan contributions of up to $10,000, or $20,000 for joint filers, and Vermont provides a 10% credit for the first $2,500 of contributions per beneficiary to its 529 plan.

However, the situation has become more complicated because of the 2017 Tax Cuts and Jobs Act. The TCJA modified the rules for 529 plans beginning in 2018, allowing tax-free distributions of up to $10,000 if used to pay tuition for enrollment or attendance at an elementary or secondary school (kindergarten through grade 12).

States Following Federal 529 Rule Change for K-12 Tuition

Many states follow the new federal treatment because their existing laws were already tied to the federal law.

For example, New Jersey announced that it follows the federal change because state law incorporates the provisions of IRC Sec. 529. So New Jersey considers a 529 withdrawal used for tuition at private, religious, elementary, and secondary schools to be a qualified higher education expense.

Similarly, because of the federal change, North Dakota announced that state taxpayers can use College SAVE 529 assets to pay for tuition expenses related to K-12 enrollment or attendance with no state tax consequences.

The status of existing state laws has not always been clear. In a preliminary report on the TCJA, New York said that it appeared distributions for K-12 tuition expenses would not be considered qualified distributions under New York law and that more review of the federal law was needed. Since then, New York has confirmed that it is not following the change. But more on non-conforming states later.

States Updating Laws to Follow 529 Rule Change for K-12 Tuition

Several states that did not automatically follow the federal change updated their laws in 2018 to do so.

For example, Wisconsin’s 2018 budget bill included a law update to follow the federal 529 rule change for K-12 tuition. Some other states in this group include:

  • Arkansas
  • Iowa
  • Kentucky
  • Maine
  • North Carolina
  • Ohio

Indiana went even further and expanded its contribution credit to specifically include amounts intended for K-12 tuition.

States Not Following 529 Rule Change for K-12 Tuition

About a dozen states are currently not following the federal 529 rule change for K-12 tuition. This group includes:

  • California
  • Colorado
  • Illinois
  • Minnesota
  • Montana
  • Nebraska
  • New Mexico
  • New York
  • Oregon
  • Vermont

For most of these states, their existing laws simply have not been updated to incorporate the federal change. However, Oregon changed its law in 2018 to remove the state tax benefit for 529 distributions used for K-12 tuition.

For states that do not follow the federal change, a 529 withdrawal for K-12 tuition may be considered an unqualified withdrawal.

A future article will discuss what that means for taxpayers when filing their 2018 state returns.

By Brian Plunkett, J.D.

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All stories by: CCHTaxGroup