529 plans, or Qualified Tuition Programs as the federal government calls them, are specialized investment accounts to give tax-advantaged savings for education expenses. 529 plans are typically the best vehicle to save for college. Thanks to the 2018 Tax Cuts and Jobs Act, you can now also reimburse yourself up to $10,000 for elementary or secondary school tuition.
Contributions to a Virginia 529 plan offer the account owner a Virginia state tax deduction. Then, distributions to reimburse for any qualified education expenses are distributed both state and federal tax-free. For those under age 70, the deduction limit is $4,000 per account per year.
Opening a 529 account can be a hassle though if you are just trying to make a one-time contribution for a friend’s child or a distant relative. As a result, a question we are frequently asked is:
Can I claim a Virginia 529 contribution deduction after contributing to an account that I do not own?
Unfortunately, the answer is that you cannot. The 529 account owner receives any state tax deductions for contributions made to their account.
The 2020 Virginia 529 Program Brochure makes this very clear stating (blue emphasis added):
Any individual or entity can contribute funds to an Account at any time but only the Account Owner will have control over the Contributions. All Contributions to an Account are deemed to come from the Account Owner for record-keeping purposes and for the Virginia state income tax deduction.
Virginia Tax Deduction. Invest529 Account Owners who file a Virginia state individual income tax return can deduct Invest529Contributions from their Virginia taxable income. The deduction is limited to $4,000 per taxable year per Virginia529 account (each separate account held within Invest529, Prepaid529, CollegeAmerica and CollegeWealth), or the amount contributed to each Virginia529 account during the year, whichever is less, with unlimited carryforward until the full amount of the Contributions has been deducted. The $4,000 per taxable year limit does not apply to Account Owners who are age 70 or above, who may deduct the entire amount of their Contributions in a single tax year. If an Account is cancelled for a reason other than the student’s death, disability, receipt of a scholarship (including attendance at a U.S. military academy), or Rollover to another Virginia529 account, any amount of the refund previously deducted from the Account Owner’s Virginia taxable income as a result of Contributions to the cancelled Invest529 Account must be added back to the Account Owner’s Virginia taxable income in the year the refund is received, in addition to any federal tax consequences. The Virginia Department of Taxation has not yet commented on how a Rollover from an Account to a Virginia ABLEnow account will be treated. We will publish an update to this document as soon as we receive further direction on this issue. Only the Account Owner of record of an Invest529 Account as of December 31 of the taxable year is eligible to take the Virginia state tax deduction for Contributions made to that Account. Individuals who choose to make Contributions to an Invest529 Account owned by another individual or entity are not eligible for the Virginia state tax deduction. The Virginia state tax deduction for UTMA/UGMA Invest529 Accounts belongs to the Beneficiary, and is reported under the Beneficiary’s Social Security number. UTMA/UGMA custodians are not eligible for the Virginia state tax deduction for Contributions made to an UTMA/UGMA Invest529 Account.
In this way, you can contribute to a 529 account which you do not own, but those contributions will be deductible for the 529 account owner only.
This can be used to your advantage in some circumstances. For example, imagine a wealthy grandparent whose only taxable income is Social Security and is living off of their large Roth IRA assets. The Virginia state tax deduction is not worth very much to them, because they do not owe much in state taxes.
Imagine as well that their child is at their peak earning potential and pays a lot in Virginia taxes, but due to the family financial lifecycle is not able to save as much as they want to towards their child’s college education.
In this example, it would be beneficial for the whole family, if the child opens a 529 account for the benefit of the beneficiary which the grandparent contributes to. In this way, the grandparent can gift the 529 funds they want to their grandchild, while the full benefit of the state tax deduction can be used by the child.
In the case of a transfer of ownership of a prepaid tuition contract or college savings trust account, the transferee shall succeed to the transferor’s tax attributes associated with a prepaid tuition contract or college savings trust account, including, but not limited to, carryover and recapture of deductions.
As such, the new owner of a plan may use the full amount of deductions for the original owner’s payments or contributions when the original owner was not able to use the deductions.
For most people this circumstance will not come up. However, if you do find yourself with a large carryforward, you may want to read the article “Virginia 529: What Counts as a Unique Account for Per-Account Deductions?” to see if you could open more 529 accounts in order to gain your full contribution deduction now for later contributions.
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