529s and Private High School Tuition

The recent tax bill that went into effect this year included a change allowing parents to use up to $10,000 annually from a 529 account to pay for private high school expenses. Parents considering taking advantage of this provision should weigh another consideration besides whether or not they have saved enough in their 529 to pay for high school in addition to college: Does your state offer the same benefit?

The new tax law applies to federal taxes, not necessarily to state ones. Currently, about 20 states align their 529 rules with federal rules, leaving 30 that do not. That means that your state may or may not deem 529 withdrawals to pay for high school to be qualified expenses. If you intend to use your 529 for high school expenses, you should check with your plan as to whether the withdrawal is qualified for state tax purposes and what the consequences are if it isn’t. Right now, many state websites say a version of what’s on the Oregon College Savings Plan site, “Only the federal tax treatment for qualified distributions was changed by the federal tax plan. At this time, states are reviewing the impact of the federal tax change to determine whether they require changes to state legislation. Additional updates pertaining to the state tax treatment for K-12 withdrawals are forthcoming.”

In addition to owing state income taxes on the gain in the account, you may be subject to a state tax deduction clawback (if you use your own state’s plan and received a tax deduction for the contribution) and a state tax penalty. Since 529 distributions are always a pro rata combination of contributions and earnings, you will see some state penalty assessed on the withdrawal. (Pro rata means that if your account is worth $20,000 and you contributed a total of $10,000, then 50% of the account is contributions and 50% is earnings, regardless of how many different investments it’s allocated between.)

Again, check with your state before withdrawing funds to pay for high school expenses because the state treatment may be different than federal. This applies whether or not the 529 account is with the state’s plan because your state of residence will impose income taxes on the distribution based on state tax law, not 529 account location.

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