Question

You have a tax client who is a single taxpayer and has one child, age 3. Your client plans on sending to the child to private elementary, middle, and high school. He also plans on paying as much as he can for the child’s college education. Provide a paragraph explanation, directed to your client, advising him on information related to a Section 529 account. Use specific numerical examples in your explanation.

Answer 1

According to the new Tax Cuts and Jobs Act, 529 plans, a tax-advantaged savings plan designed to encourage saving for future college costs, have recently been expanded to include elementary and secondary school expenses. This means that taxpayers will be able to withdraw up to $10,000 per year tax-free for elementary and high school expenses, such as tuition and books.A 529 plan is a versatile savings account offering federal, and sometimes state, tax benefits, while minimizing impact on financial aid. These plans are operated by a state or educational institution, and are designed to help families set aside funds for future college and K-12 education costs.

529 plans offer unsurpassed income tax breaks. Although contributions are notdeductible, earnings in a 529 plan grow federal tax-free and will not be taxed when the money is taken out to pay for college.

But unfortunately, a federal income tax deduction is not one of them. You can't claim a federal income tax deduction for contributions you make to your 529 plan. However, certain states offer state income tax deductions for contributions to 529 plans.

The top tax bracket is 39.6% on taxable income above $406,750 for single taxpayers

A 3.8% net investment income tax is applied to the lesser of net investment income or modified AGI above $200,000 (singles)

An additional Medicare surtax of 0.9% is due on earned income above $200,000 (singles)

The top rate on qualified dividends and long-term capital gains is 20% for taxpayers in the top tax bracket.

For example, a grandmother and grandfather could together give up to $28,000 to each of their grandchildren. If the contribution exceeds the annual gift tax exclusion, then five-year gift tax averaging would apply. This treats the contribution as having been made proportionately over a five-year period beginning with the current tax year. If the contributor dies during the five-year period, only part of the gift will be treated as completed and hence removed from the contributor’s estate. The portion of the gift corresponding to periods after the death of the contributor will remain in the contributor’s estate. For example, if an aunt gives $30,000 to her nephew’s 529 College Savings Plan, it will be treated as though she gave $6,000 per year for five years. If she dies during the second year, $12,000 will be excluded from her estate and $18,000 will be included.