Understand the Tax Benefits of 529 Plans
When you invest in Bright Start, your earnings grow federal-tax free, and are tax-free when they’re withdrawn for qualified college expenses.
If you live in Illinois, you also get some added state tax benefits. Contributions to your Bright Start account are tax deductible. You’ll enjoy a deduction of up to $10,000 per parent, per year ($20,000 if married and filing jointly) and you pay no state income tax on earnings and withdrawals that are used for qualified college expenses1. You can also deduct the contribution portion (but not earnings) of rollovers from other state 529 plans.
But keep in mind – if the money is spent on non-qualified college expenses, you’ll pay taxes on your earnings, plus an additional 10% federal tax. And the amount of any deduction previously taken for Illinois income tax purposes is subject to recapture if assets are rolled over to a non-Illinois 529 plan. Other states offer similar benefits to their residents, so if you live outside of Illinois it’s a good idea to do some comparison shopping.
Invest Your Tax Refund
If you will be receiving a federal or state tax refund, consider investing it into your Bright Start 529 account. Both your federal and state tax returns allow you to deposit all or a portion of any tax refund.
Here is the information you will need when completing the “Refund – Direct Deposit” section of your federal and/or Illinois tax returns. Please use the following bank information:
Routing Number: 10 491 0795
Type of Account: Savings
Account Number: 4529 followed by your Bright Start 10-digit account number
Withdrawal Reporting Form
Did you request a withdrawal from your Bright Start 529 account in 2017? If so, you will need IRS Form 1099-Q (mailed by Bright Start by January 31, 2018). The 1099-Q is an IRS tax form showing the total amount of all withdrawals requested to the same payee as well as the principal and earnings portions of those withdrawals.1
The Account Owner will receive the 1099-Q if they check was payable to the Account Owner.
The Beneficiary receives the 1099-Q for any withdrawals paid to the Beneficiary or to the school.
We recommend that you keep the receipts and documentation of your college expenses with your tax paperwork in the event there are any questions about the amount you have withdrawn. You should discuss any tax reporting requirements with your tax professional.
If you made larger gifts in 2017 (i.e., typically over $14,000), don’t forget to mention them to your tax professional so they can determine if any special IRS filings are required. If you took advantage of the special five-year, front-loading election allowed for 529 plans, please notify your tax professional so they can prepare any necessary Gift Tax Return. The due date for filing is April 15.
Other Important Tax Information and Considerations
The tax benefits afforded to 529 plans must be coordinated with other programs designed to provide tax benefits for meeting Qualified Higher Education Expenses to avoid the duplication of such benefits. You should consult with a qualified tax advisor with respect to the various education benefits.
Taxable Portion of a Distribution
The part of a distribution representing the amount paid or contributed to a qualified tuition program doesn’t have to be included as income. This is a return of the investment in the plan. The designated Beneficiary generally doesn’t have to include any earnings distributed from a qualified tuition program as income if the total distribution is less than or equal to adjusted Qualified Higher Education Expenses. To determine if your total distributions for the year are greater or less than the amount of Qualified Higher Education Expenses, you must compare the total of all qualified tuition program distributions for the tax year to the adjusted Qualified Higher Education Expenses. Adjusted Qualified Higher Education Expenses are the total Qualified Higher Education Expenses reduced by any tax-free educational assistance. Tax-free educational assistance includes: the tax-free portion of scholarships and fellowship grants; veterans’ educational assistance; the tax-free portion of Pell grants; employer-provided educational assistance; and any other tax-free payments (other than gifts or inheritances) received as educational assistance.
Coordination with American Opportunity and Lifetime Learning Credits
An American Opportunity or Lifetime Learning Credit can be claimed in the same year the Beneficiary takes a tax-free distribution from a qualified tuition program if the same expenses are not used for both benefits. This means that after the beneficiary reduces Qualified Higher Education Expenses using tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit.
Coordination with Coverdell Education Savings Account Distributions
If a Designated beneficiary receives distributions from both a qualified tuition program and a Coverdell Education Savings Account in the same year and the total of these distributions are more than the Beneficiary’s adjusted Qualified Higher Education Expenses, the expenses must be allocated between the distributions. For purposes of this allocation, disregard any qualified elementary and secondary education expenses.
Coordination with Tuition and Fees Deduction
A tuition and fees deduction can be claimed in the same year the Beneficiary takes a tax-free distribution from a qualified tuition program if the same expenses are not used for both benefits.
Qualified Higher Education Expenses
IRS Publication 970 defines Qualified Higher Education Expenses as follows: These are expenses related to enrollment or attendance at an eligible educational institution. As shown in the following list, to be qualified some of the expenses must be required by the institution and some must be incurred by students who are enrolled at least half-time.
- The following expenses must be required for enrollment or attendance of a designated Beneficiary at an eligible educational institution.
- Tuition and fees.
- Books, supplies, and equipment.
- Expenses for special needs services needed by a special needs Beneficiary must be incurred in connection with enrollment or attendance at an eligible educational institution.
- Expenses for room and board must be incurred by students who are enrolled at least half-time. The expense for room and board qualifies only to the extent that it isn’t more than the greater of the following two amounts:
- The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
- The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.
- The purchase of computer or peripheral equipment, computer software, or internet access and related services, if it is to be used primarily by the Beneficiary during any of the years the Beneficiary is enrolled at an eligible educational institution. This does not include expenses for computer software for sports, games, or hobbies unless the software is predominately educational in nature.
Recontribution of Refunded Amounts
If a student receives a refund of qualified education expenses that were treated as paid by a 529 distribution, the student can recontribute these amounts into a 529 for which they are the Beneficiary within 60 days after the date of the refund to avoid the need to figure the taxable part of the 529 distribution.Please consult with your tax professional regarding the proper reporting and record retention requirements.