A qualified tuition program (“QTP”, also commonly known as a “section 529 plan”) is a program set up and managed by a state that allows a contributor to either prepay a beneficiary's qualified education expenses at an eligible educational institution or to contribute to an account that is designated to pay those expenses in the future.
There are many benefits to QTPs including the following:
- While in the account, earnings on the contributions accumulate tax free.
- Generally, the beneficiary does not have to include earnings from the QTP as income on their tax return.
- Distributions are not taxable if the full distribution is used to pay for qualified education expenses.
- Contributors can deduct their contributions to Pennsylvania QTPs from their Pennsylvania taxable income (up to $15,000 per beneficiary, per year). Married couples can deduct up to $30,000 per beneficiary, per year if each spouse has taxable income of at least $15,000.
- Contributors can deduct their contributions to Maryland QTPs (specifically under the College Investment Plan) from their Maryland taxable income (up to $2,500 per beneficiary, per year). Contributions in excess of the $2,500 can be deducted for up to the next 10 years from when the original contribution was made.
Click here for more information on QTPs in Pennsylvania and Maryland.
Changes to Qualified Tuition Program tax-free distributions
Before the Tax Cuts and Jobs Act (TCJA), a distribution from a QTP was tax-free if it was used to pay for “qualified higher education expenses” (tuition and fees for schooling after high school) of the beneficiary (student). Effective for distributions after 2017, the TCJA broadens the definition of “qualified higher education expenses” to include tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school. The TCJA does limit the combined distributions to $10,000 per beneficiary when the expenses are being used towards tuition and fees for elementary or secondary public, private, or religious school.
Estate Tax Planning Using Qualified Tuition Programs
Gift Tax Background
- A gift is any transfer to an individual, either directly or indirectly, where full consideration (measured in money or money's worth) is not received in return.
- The maximum amount an individual can gift to someone other than their spouse during 2018 is $15,000 before gift tax is imposed. The limit from 2014 - 2017 was $14,000.
- The donor is generally responsible for paying the gift tax imposed.
- If married couples make the proper election, both spouses can give the maximum amount to each donee (total of $30,000 for 2018) without having gift tax imposed.
- The annual exclusion applies to gifts to each donee. For example, an individual and their spouse can each give $15,000 to each of their children, grandchildren, nieces, and nephews, etc. annually without having gift tax imposed.
Using Qualified Tuition Programs as a Tool to Avoid Gift Tax and to Estate Plan
Funds contributed to QTPs are deemed gifts, and therefore gift tax rules apply to the contributions. However, gifts to QTPs are very unique because they qualify for a special 5-year averaging. For example, if a proper election is made, gifts of up to $75,000 can be made in 2018 ($150,000 for married couples making the proper election) to QTPs for each donee/beneficiary. Then the gifts made in 2018 to the QTPs are averaged out over 2018, 2019, 2020, 2021, and 2022 and qualify for the gift tax exclusion in each of those years. This allows individuals to move assets into tax-deferred investments and out of their estate more quickly.