A Closer Look at the 529 Expansion Reveals Uncertainty and Disappointment About Lower Education Expenses

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Thanks to the Tax Cuts and Jobs Act, the qualified expenses of 529 accounts have been expanded to include elementary and secondary education expenses. This opens up the usefulness of 529 accounts to more families. However, a closer look at the U.S. Code reveals a bit of uncertainty.

U.S. Code 529(e)(3)(A) describes what are qualified expenses from a 529. It currently reads:

In general The term “qualified higher education expenses” means—
(i) tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution,
(ii) expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with such enrollment or attendance, and
(iii) expenses for the purchase of computer or peripheral equipment (as defined in section 168(i)(2)(B)), computer software (as defined in section 197(e)(3)(B)), or Internet access and related services, if such equipment, software, or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution.

Clause (iii) shall not include expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature. The amount of cash distributions from all qualified tuition programs described in subsection (b)(1)(A)(ii) with respect to a beneficiary during any taxable year shall, in the aggregate, include not more than $10,000 in expenses described in subsection (c)(7) incurred during the taxable year.

Now, the Tax Cuts and Jobs Amendment added 529(c)(7) to the Code, which reads:

Any reference in this subsection to the term “qualified higher education expense” shall include a reference to expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

The confusion comes in to whether (c)(7) is saying, “reread (e)(3)(A) and where it implies higher education simply read it as higher, elementary, or secondary education” or if (c)(7) is saying, “Regardless of what (e)(3)(A) says, expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school is a qualified expense.”

If it is the latter, then it sounds like almost any tuition is a qualified expense, which seems exceedingly generous.

It if is the former, then the problem is that no lower school is “an eligible educational institution” because that requirement is defined in 529(e)(5) as “an institution (A) which is described in section 481 of the Higher Education Act of 1965 (20 U.S.C. 1088), as in effect on the date of the enactment of this paragraph, and (B) which is eligible to participate in a program under title IV of such Act.” This basically amounts to institutions allowed to participate in federal student assistance programs or is “recognized by the Secretary” as a program that can receive financial aid (U.S.C. 1088).

I don’t think Congress intended to expand federal student aid to lower schools.

Sometimes the IRS FAQ can shed light on this issue, but sadly not in this case. Their FAQs currently read:

Q. What is an eligible educational institution?

A. An eligible educational institution is generally any college, university, vocational school, or other postsecondary educational institution eligible to participate in a student aid program administered by the U.S. Department of Education. Note that, beginning in 2018, the term “qualified higher education expense” includes expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.

The same ambiguity exists in their answer here, although I would guess that the correct interpretation is that any tuition is the only qualified expense.

On the topic of which schools count, the IRS has issued some clarifying guidance in Notice 2018-58 where they say:

The Treasury Department and IRS intend to issue regulations defining the term “elementary or secondary” to mean kindergarten through grade 12 as determined under State law, consistent with the definition applicable for Coverdell education savings accounts in § 530(b)(3)(B).

U.S. Code 530(b)(3)(B) says:

The term “school” means any school which provides elementary education or secondary education (kindergarten through grade 12), as determined under State law.

This changes the definition of a school from a federal matter to a State matter. There are some states who are very loose in their definition of a school and others that are very strict. The Coalition for Responsible Home Education has a nice summary of how different states handle nontraditional schools.

Now, The IRS intends to use the Coverdell definition for 529 accounts, but they have not finalized this ruling yet. Thus, we still don’t know what the new 529 law means for elementary or secondary schools. For this reason, you should seek tax advice from a qualified tax preparer about this issue before proceeding with your reimbursement distributions.

Another disappointment of the final code is that homeschooling expenses seem to have been quietly excluded from the final law.

Although the conference agreement simply said, “The conference agreement follows the Senate amendment,” the actual Senate bill has different text than appears in the final U.S. Code amendment.

Here is what the Senate bill said (c)(7) should be amended to:

(1) In general.–Section 529(c) is amended by adding at the end the following new paragraph:
“(7) Treatment of elementary and secondary tuition.–Any reference in this subsection to the term `qualified higher education expense’ shall include a reference to–
“(A) expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school, and
“(B) expenses for–
“(i) curriculum and curricular materials,
“(ii) books or other instructional materials,
“(iii) online educational materials,
“(iv) tuition for tutoring or educational classes outside of the home (but only if the tutor or instructor is not related to the student),
“(v) dual enrollment in an institution of higher education, and
“(vi) educational therapies for students with disabilities, in connection with a homeschool (whether treated as a homeschool or a private school for purposes of applicable State law).”.

This is how the conference agreement summarized that Senate bill:

The provision also modifies the definition of higher education expenses to include certain expenses incurred in connection with a homeschool. Those expenses are (1) curriculum and curricular materials; (2) books or other instructional materials; (3) online educational materials; (4) tuition for tutoring or educational classes outside of the home (but only if the tutor or instructor is not related to the student); (5) dual enrollment in an institution of higher education; and (6) educational therapies for students with disabilities.

And yet, curiously, this text about homeschooling did not make it into the final U.S. Code 529. I would guess that the conference agreement document was over simplified and in actuality they merged the House and Senate versions more piecemeal than was suggested.

As a result, although we had our hopes set that homeschooling expenses might have been included as qualified expenses, it looks as though they are not. It is only “expenses for tuition in connection with enrollment or attendance at an elementary or secondary public, private, or religious school.”

All of that uncertainty being said, assuming that your institution does qualify as an eligible institution, you might be able to save on your state taxes by flowing expenses through a 529 account.

With a Virginia 529 account, Virginia taxpayers who own 529 accounts may contribute what they’d like to the 529 account and then deduct on their state tax return contributions up to $4,000 per account per year with an unlimited carryforward to future tax years. Then, if your elementary or secondary institution is eligible, you can reimburse yourself up to $10,000 in qualified education expenses, which might just be tuition for lower education.

In this way, you can save money on your state taxes by flowing the tuition you would have paid for anyway through a 529 account.

Photo by Joel Overbeck on Unsplash

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Megan Russell has worked with Marotta Wealth Management most of her life. She loves to find ways to make the complexities of financial planning accessible to everyone. Her most popular post: The Complete Guide to Your Washing Machine