Plus, distribution times, transportation costs, and estate taxes.
College-savings expert Susan Bart answers advisors' questions on 529 plans and other education-planning matters. E-mail your questions to firstname.lastname@example.org.
Question: My client is the owner of the 529 accounts for his son and daughter but their grandparents are the major contributor to these accounts. My client just moved these 529 accounts from one state to Illinois a year ago to get tax benefit from his own state. Now, my client is planning on filing Chapter 7 bankruptcy protection. Are these accounts protected? If the $5,000 exclusion applies, can his creditors go after the portion that the grandparents contributed and also the gain from the investment? Since the Illinois accounts were set up a year ago, will the court consider all of the money contributions from my client?
Susan: If your client is an Illinois resident, and rolled over the 529 accounts from a program in another state to Illinois to claim an Illinois income tax deduction, your client may not be entitled to the Illinois income tax deduction. The Illinois statute states that for taxable years beginning on or after Jan. 1, 2005, there is a maximum deduction of $10,000 for contributions to Illinois's plan, "except that amounts excluded from gross income under Section 529(c)(3)(C)(i) of the Internal Revenue Code shall not be considered moneys contributed under" the Illinois statute. Section 529(c)(3)(C)(i) is the provision that excludes from income taxation any 529 distribution that, within 60 days, is transferred to another 529 account for the benefit of the same beneficiary or a new beneficiary who is a member of the family of the old beneficiary.
With respect to the bankruptcy, a 529 account for a child, stepchild, grandchild or step grandchild of the debtor is excluded from the bankruptcy estate, but only if the funds were contributed more than a year before the bankruptcy petition, and only to the extent of $5,000 with respect to funds contributed within 720 days of the bankruptcy petition. The bankruptcy statute should be construed to look to the date of the original contribution to the 529 account, ignoring any rollovers that qualify under Section 529(c)(3)(C)(i), but I cannot cite you any authority on that point. On the other hand, if your client made a distribution to himself from the original 529 plan, and then later contributed the funds to Illinois accounts in a manner that did not qualify under Section 529(c)(3)(C)(i), for example if the contribution was not made within 60 days of the distribution, the bankruptcy provision might apply from the date of the new contribution and your client might be considered the owner of all of the funds for bankruptcy purposes. (In addition, the distribution should be treated as a nonqualified distribution for income tax purposes, with income tax and the penalty imposed on any earnings in the original account and the new contribution to the Illinois account should be treated as a gift from your client.)
The even more interesting question is, assuming the rollover was a qualified rollover, whether the funds contributed by the grandparents should be excluded entirely from the parent's bankruptcy estate because they were contributed by the grandparents. It seems unfair from a policy perspective to use the grandparents' assets to pay the parent's creditors, especially when the grandparents' contribution was intended to pay for the grandchildren's college education. On the other hand, the parent does have unrestricted legal access to the funds and it seems unfair to discharge the parent's debts, but leave the parent with effective access to the 529 account for his personal use. I would ask the bankruptcy attorney if the account owner of the portion contributed by the grandparents can be changed to someone other than the debtor.
Question: My daughter is a freshman this year at Wake Forest. We paid for fall 2009 in August and spring 2010 at the end of November. When I submit for reimbursement from the 529 Plan, do I have to ask for a distribution for the spring 2010 expenses before year end 2009 because I paid the expenses in 2009 or can I wait until December 2010 because the expenses related to calendar year 2010?
Susan: To be safe, any 529 distribution taken for expenses you paid in 2009 should have been taken in 2009. The 2008 Advance Notice from the IRS proposed a rule that would permit a distribution taken in 2009 to be used for expenses paid in 2009 or on or before March 31, 2010. However, the Advance Notice did not propose a rule that would permit a distribution to be taken in 2010 for expenses paid in 2009. Nonetheless, we can hope that final regulations will provide such flexibility.
Question: My daughter is a senior this year at University of Maryland. She studied for the spring semester of her junior year [Jan-July 09] at the University of Nice in France. We had to pay for plane tickets to and from Nice. We also had to pay for housing for her--she shared a small apartment with another student in the program. This housing cost about $1,500 more than UMD would have charged her to live in the dorm at UMD for the semester but was nonetheless still reasonable. The housing was not owned or operated by UMD but was on a list of available housing opportunities provided to the kids by UMD. Do the plane fare and extra housing cost fall within the definition of qualified higher education expenses?
Susan: Unfortunately transportation costs are not included in the definition of qualified higher education expenses. Room and board is limited under 529(e)(3)(ii) to the allowance included in the school's cost of attendance.
Question: Now that the estate tax is repealed for 2010, can I make unlimited gifts to 529 accounts for my grandchildren without tax consequences?
Susan: NO! First, Congress may try to retroactively reinstate the estate and generation-skipping transfer taxes during the year. Although retroactive reinstatement may be challenged in court on constitutionality grounds, the courts have allowed retroactive tax legislation under certain circumstances.
Even assuming that the transfer tax rules don't change retroactively later this year, the legislation that currently applies to 2010 repeals only the estate and GST taxes, not the gift tax. The gift tax rate, however, is reduced from 45% to 35%. Thus gifts to a beneficiary, including gifts to a 529 account for such beneficiary, in excess of $13,000 in 2010 will still be subject to gift tax. Of course, married couples can still make the split-gift election so that they can give $26,000 per beneficiary in 2010 without gift tax. And the five-year election can still be made, which would permit an individual to give up to $65,000 to a 529 account without gift tax ($130,000 for a married couple making a split-gift election).