Earlier this year, we looked at how states were responding to the change in federal tax code that allowed the use of 529 savings plans for K-12 tuition. Originally, 529s were designed to incentivize saving for college by allowing after-tax contributions to 529s to grow free of federal income tax. The new federal tax code expands qualified higher education expenses to include elementary or secondary school tuition (public, private or religious).
Now, families can withdraw up to $10,000 each year per beneficiary to use for K-12 tuition, free of federal income tax. However, some state laws don’t automatically conform to the new federal law, and potential state tax implications must be taken into consideration.
There are two key issues at hand as states decide whether they will approve or reject the expanded use of 529 plans:
- State tax recapture – States must determine if they will conform their tax code to the federal tax code regarding 529s and count K-12 tuition as a “qualified higher education expense” as newly defined in federal code (26 USC § 529). If states conform their tax codes, families will be able to withdraw 529 funds to use for K-12 tuition without those funds being subject to state tax recapture.
- State tax deductions and credits – There are 34 states plus Washington, D.C. that offer a state tax deduction or credit for contributions made to 529 plans when the funds are used for qualified higher education expenses. Those states must determine if they will also extend the deduction or credit for contributions made to 529 plans when the funds are ultimately used for K-12 tuition.
Given how some state codes are written, some states didn’t need legislation to allow 529 funds to be used for K-12 tuition. For example, Delaware’s tax code and 529 definitions (i.e. what is a qualified expense) align with the federal tax code. Therefore, when the federal changes were made, they automatically took effect under Delaware law.
On the other hand, some states didn’t automatically conform to federal tax law. A few states have passed (and others are currently considering) legislation to conform their state codes to the new federal tax code. During a special legislative session, the Arkansas Governor signed into law Act 8 and Act 15, which allow families to use 529 funds for K-12 tuition exempt from state income taxes and extends the state tax deduction for contributions to 529 plans that are ultimately used for K-12 tuition. Also, last month in Idaho, the Governor signed HB 463 into law, which conforms Idaho tax law to the new federal tax code, and the guidance on the plan website has been updated to reflect this change.
Other states like Oregon have taken a different approach. A bill currently awaiting the Governor’s signature, HB 4080, would make it so that families cannot receive state tax benefits on 529 funds used for K-12 tuition. As the Oregon State Treasury explained, 529 plans used for K-12 tuition will still receive the federal tax break on their earnings, but the state will not extend any tax benefits for K-12 use: “For Oregon tax purposes, the taxpayer will need to add back to their taxable income any amount of that K-12 distribution that received the state tax deduction” and the taxpayer would need to count any earnings in the 529 plan as state taxable income.
Of course, this policy change is not an educational panacea. In fact, it is an admittedly limited change in education policy. Use of 529 plans is not widespread: Less than three percent of families utilize 529 plans, and the families who do use the plans tend to have higher incomes. Additional efforts are needed in every state to increase opportunity for those who need it most, because every child, in every household, deserves access to a high-quality education.
Still, this policy change is one that has implications for families (and states) nationwide. It has moved the ball forward, closer to the goal of creating educational opportunity for all students, and a policy that expands educational opportunity is a policy worth championing.
About the author
Tori Bell is the Policy Analyst for Education Opportunity at ExcelinEd, where she works with state leaders to build and implement supportive education opportunity policies. Prior to joining ExcelinEd, Tori worked for a Member of Congress and managed his education policy portfolio. She received her Bachelor of Arts Degree in Political Science from Washington and Lee University, where she also minored in Education Policy and Poverty and Human Capability Studies. Tori currently resides in Washington, D.C.