A 529 Plan is exempt from federal income tax. When funds are withdrawn to pay for the beneficiary’s education expenses, such withdrawals are not taxable if the withdrawals are for the beneficiary’s “qualified higher education expenses.”
The SECURE legislation expands the expenses that are considered “qualified,” allowing them to be paid with distributions from a 529 Plan without triggering federal income tax. Qualified higher education expenses now include costs associated with registered apprenticeships and up to $10,000 (cumulative, not annual) of qualified student loan repayments of principal and interest of the 529 Plan’s beneficiary. However, amounts excluded from income as a qualified student loan repayment will reduce amounts otherwise deductible as student loan interest. This new provision is effective for distributions made after December 31, 2018.
For qualified student loan repayments, the statute has a special rule that allows student loan repayments of the beneficiary’s siblings to be considered qualified student loan repayments. The wording of the statute, however, is unclear and it would be best to consult with your tax advisor before trying to take advantage of this special rule for siblings’ student loan repayments.
NOTE: Because this change to 529 Plans was enacted so late in the year, you might have already paid 2019 expenses that are now “qualified” for reimbursement from a 529 Plan (the effective date for this change is for distributions made after December 31, 2018).
If you can get reimbursed in 2019 for those expenses, that would fall under this new rule. If, however, you plan to get reimbursed in early 2020 for those 2019 expenses, the statute is silent as to whether a withdrawal from a 529 Plan must be in the same year as the qualified expenses are incurred.
Prior to enactment of the Tax Cuts and Jobs Act in December 2017, the unearned income of children could be income taxed at the top marginal rate of their parents. This was known as the “kiddie tax” and involved complex calculations. The Tax Cuts and Jobs Act repealed the kiddie tax (through 2025) and instead taxes the unearned income of children at the same compressed income tax rates that apply to trusts. SECURE repeals that change and re-instates the kiddie tax.
This change is motivated in part because of the unintended consequences of the 2017 legislation. The kiddie tax was aimed at high net worth individuals, to prevent the shifting of investment income to children’s lower brackets. However, other examples of “unearned income” can include scholarships and military survivor benefits, which are received by those in lower tax brackets. Having those items taxed at parents’ rates under the kiddie tax meant those items could still be taxed at lower rates. The 2017 change, however, would cause those items of income to be taxed at the same high rates as apply to trusts, which rates are very compressed and quickly reach the top marginal rate of 37%. As a result, under the 2017 legislation these items are subject to a higher rate of tax.
This change is effective for tax years beginning in 2020. However, you can elect to apply this change to 2018 or 2019 (or both).
The SECURE Act makes many changes that will have a significant impact on planning. We invite you to contact your Withum partner if you have any questions on this new, important legislation.