Virginia 529 Tax Deduction

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Virginia is one of several states that offers a tax deduction for 529 plans. A Virginia 529 plan also qualifies for federal tax benefits.

Virginia 529 Plan Deduction

Virginia taxpayers get a state income tax deduction for 529 plan contributions.

Only contributions to the Virginia 529 plan are eligible. You can’t take a deduction if you choose to use another state’s 529 plan. However, you can use your Virginia 529 plan for any eligible educational institution even out of state.

If you’re under 70, there’s a limit of $4,000 per account per year. If you’re 70 or older, there is no limit.

If you’re under 70 and contribute more than $4,000, you can deduct the remaining amount in the following year. There’s generally no limit on how far you can carry forward extra contributions.

Examples:

  • Contribute $5,000 this year. Deduct $4,000 this year and $1,000 next year.
  • Contribute $5,000 per year for five years. Deduct $4,000 each year. In the 6th year, you can deduct $4,000 of the extra $5,000. In the 7th year, you can deduct the remaining $1,000.
  • Contribute $5,000 per year for three years and turn 70 in the third year. Deduct $4,000 for the first two years. In the third year, there’s no longer a limit. Deduct the full $5,000 plus the $1,000 extra from each of the first and second years ($7,000 total).

If you’re contributing for two (or more) people, it’s $4,000 per year per person. So if you have two children, you can contribute $8,000 in a year.

There are split opinions on whether multiple accounts for the same person lets you take a higher deduction.

Some people say that it’s $4,000 per person even if you have multiple accounts for the same person. That’s similar to how IRA deduction limits work; you can’t double your IRA deduction by opening a second IRA.

If you follow the per-person interpretation, there is a way to increase your deduction. You can open additional accounts for other beneficiaries and later transfer them to your child.

For example,

  • Mother opens account for child
  • Father opens account for child
  • Mother opens account for self
  • Mother opens account for father
  • Father opens account for self
  • Father opens account for mother

Each account would be a different account that allows a $4,000 state tax deduction. When it’s time to pay for qualified higher education expenses, you can generally transfer the account to a spouse, child, or another qualified family member with no taxes or fees.

Other people say you don’t need to worry about opening accounts for other beneficiaries (such as yourself or your spouse). Instead, they say that you can just open multiple accounts.

The Virginia 529 plan offers multiple portfolios with different investment options and levels of risk. Each portfolio creates a separate account. An account owner can’t open two accounts with the same portfolio.

The people who say opening multiple portfolios can give you multiple $4,000 deductions for the same beneficiary rely on the definition of account in the Virginia 529 plan brochure.

“Account” is the separate Invest529 account set up for each Portfolio by an Account Owner. Since each Account can have only one Portfolio, the same Account Owner may have multiple Accounts for the same Beneficiary in different Portfolios. Each investment by the same Account Owner will result in a separate Account as long as the Account Owner, the Beneficiary or the Portfolio is different. The same Account Owner may not establish multiple Accounts for the same Beneficiary in the same Portfolio.

Virginia Tax Commissioner ruling 10-240 seems to support that opening multiple accounts, even for the same child, allows you to take a $4,000 deduction for each account.

Transaction #2

Taxpayer invested $5,000 each into two separate VEST portfolios in 2009. No other contributions to a college savings account were made by Taxpayer in 2009. Taxpayer seeks a determination as to the tax treatment of these contributions.

The VCSP provides that each investment by the same account owner establishes a separate VEST account if the account owner, beneficiary, or portfolio is different. Based on the information provided by the Taxpayer, it appears that the two portfolios are different. Assuming this is true, the portfolios would be treated as two separate VEST accounts.

Pursuant to Va. Code § 58.1-322(D)(7)(a), a taxpayer is permitted to take a deduction equal to $4,000 per savings trust account. Therefore, assuming that Taxpayer is the owner of both accounts, he is entitled to an $8,000 deduction in 2009. He is permitted to carry forward the remaining $2,000 deduction to the following taxable year. Please note that this outcome would be different if the VSCP treated the two portfolios as one account

Note however that these are older types of accounts and some rules have since changed. I wasn’t able to find any more current guidance to confirm.

If you intend to deduct more than $4,000 in a year for the same beneficiary, talk to your tax advisor.

How much is the Virginia state tax deduction for a 529 plan?

Assuming you’re in the highest tax bracket with a marginal income tax rate of 5.75%, the deduction for a $4,000 contribution is $230. ($4,000 x 5.75%)

If your Virginia adjusted gross income puts you in a lower tax bracket, your deduction will be lower. If you don’t owe income taxes, you won’t get a refund for contributing to a 529 plan.

What’s the limit on 529 plan contributions?

Virginia 529 plan allows each beneficiary to have a maximum balance of $550,000. That’s per student not per account owner. So two parents can’t contribute $550,000 each for the same child.

Once a beneficiary reaches $550,000, new contributions for that beneficiary are blocked.

Some plans, such as Prepaid Tuition or a Tuition Track Portfolio Account may have their own limits.

If you contribute $4,000 per account, the annual deduction limits will apply.

What if I’m already in school?

If you’re already in school, there is no minimum amount of time to hold money in a 529 plan. You can contribute funds and then immediately withdraw them to pay for qualified expenses.

Note that it may take a few days to transfer funds and for funds to be available for withdrawal (just like any other bank transfer).

But before you do this, make sure you review the potentially more valuable federal tax savings.

Federal Tax Benefits for 529 Plans

There is no federal tax deduction or tax credit for 529 plans. However, you don’t have to pay taxes on the investment earnings inside of the account.

You can also make tax-free withdrawals as long as you’re paying for qualified higher education expenses. If the beneficiary doesn’t use all of the money, account transfers to other family members are also generally tax-free.

Note that 529 plans can affect your Lifetime Learning Credit or American Opportunity Tax Credit. You generally can’t claim two tax benefits for the same qualified education expenses.

So you can’t claim an education credit for expenses you paid for with your 529 plan. You can claim an education credit if you use other funds first.

  • The Lifetime Learning Credit is usually equal to 20% of your first $10,000 in qualified higher education expenses each year (maximum $2,000 credit per year).
  • The American Opportunity Tax Credit is usually equal to your first $2,000 in qualified higher education expenses plus 25% of your next $2,000 in qualified expenses (maximum $2,500 credit per year).

Especially if you qualify for the refundable American Opportunity Tax Credit, many tax advisors suggest trying to claim these credits before using 529 plan money. The credits are usually worth far more than saving up to 5.75% in Virginia state taxes.

However, if you wouldn’t be able to use up your 529 plan money before you finish school, your options are:

  • Withdraw it and pay a 10% penalty plus income taxes
  • Save it for a child
  • Save it for possibly going back to school

So you may need to crunch the numbers or talk to a financial planner if you plan to save aggressively.

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