529 plans are tax-advantaged savings plans that have traditionally been used by families to pay for their children’s college expenses. Contributions grow tax-deferred and may be withdrawn tax-free for qualifying expenses. These plans have always been a powerful planning tool and may have become even more powerful as a result of recent federal tax law changes. However, there is also substantial uncertainty about the practical implications of those changes.
Changes in the Law
The Tax Cuts and Jobs Act, signed into law in December 2017, changes the U.S. Tax Code Section 529 to include “tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school” in the definition of “qualified higher education expenses.” Effectively, this change expands the definition of allowable “qualified expenses” to include tuition expenses prior to college, increasing opportunity for families to benefit from the tax advantages of 529 plans. Many families are now wondering what the parameters of this expansion are and how they can take advantage of it.
Generally, families living in the state of Washington may be able to use 529 plan money (without losing its tax-advantaged character) to fund K-12 education if 1) the school at which the 529 funds are being used charges ‘tuition’, and 2) the sponsoring state (the state in which the 529 plan was opened) has adopted the federal law change and otherwise conforms with the new rules.
There are, however, two major restrictions on the use of the 529 funds for K-12 education: 1) there is a limit on withdrawals of up to distributions of $10,000 per child per year, regardless of the number of contributing plans there are, and 2) the funds can only be used for tuition expenses. As a result of the tuition expenses restriction, this rule change does not cover Washington’s Running Start Program, or expenses attributed to traditional homeschooling, since there is no ‘tuition’ being paid in these scenarios. Additionally, since the state of Washington does not have a state income tax, there are no state tax implications of the rule change. In states that do have a state income tax, there could be additional considerations for residents to consider when evaluating whether to use 529 funds for K-12 tuition expenses.
Additionally, since 529 plans are run by the states as opposed to the federal government, the sponsoring state matters. Families are not restricted to opening a plan in the state in which they live, and many families have plans in various states. As a result, the laws and rules of the sponsoring state of a child’s 529 plan could affect whether the funds from that 529 plan may be used for their K-12 tuition. Before using the 529 funds, the sponsoring state’s laws regarding the use of 529 funds should be confirmed to ensure they have conformed with the federal law change.
The K-12 school where the funds may be used can be of the family’s choosing and there are no apparent restrictions on the type of school the child attends. As with other tax laws, however, this could change in the future, especially considering there have long been requirements for the type of college a child must attend in order to use tax-advantaged 529 funds (e.g. the school must be accredited). For now, so long as the elementary or secondary public, private, or religious school charges tuition, the school seemingly qualifies. However, if the school charges a single fee and does not separately charge or otherwise carve-out “tuition” from other school expenses such as room and board, there is a risk the use of 529 funds may not be allowed (without losing its tax-advantaged character).
Since this law change is so new, the rules defining how it may be used are constantly changing. Before a family decides to use 529 plan funds to pay for K-12 tuition expenses, it is important to consult with a tax advisor. For more information regarding the use of 529 plan funds, please contact Stephanie Gero or one of the attorneys in MPBA’s Estate Planning Department at 206-682-7090.