Legal Matters: Tips on tax consequences of college saving plans

Last month, the family high school graduate strode confidently across the stage to receive a diploma.

This month, she may be looking forward to college. If you have been contributing to the Maryland Prepaid College Trust or the Maryland College Investment Plan, and you now plan to withdraw money for college expenses, you want to be aware of any possible tax issues.


When you contribute to a 529 plan, whether the Maryland Prepaid College Trust or the Maryland College Investment Plan, the state comptroller’s office advises that you may be able to claim a deduction up to $2,500 on your state income tax return.

Contributions are not deductible on your federal tax return. But earnings from a 529 plan do not count as income for federal tax purposes if they are used for qualified education expenses such as tuition fees and books.

The Internal Revenue Service warns that you may face gift tax consequences if your contributions to a beneficiary are higher than $14,000 in one year.

In addition to the prepaid trust and college investment plans, the General Assembly authorized a Maryland Broker-Dealer College Investment Plan that would allow families to put money into an investment account, using private advisers. However, the plan is not yet operating, according to the Maryland Manual online,

Brief overview of the two active plans. The prepaid college trust is a pooled fund that requires you to invest a minimum of one semester’s tuition, by lump sum, monthly or annual payments. The trust allows you to lock in tuition at today’s rates at any Maryland public college or up to a weighted average at many private or out-of-state colleges.

The college investment plan lets you invest in one of several T. Rowe Price mutual funds, contributing by lump sum or monthly, for use at any college or university. If you contribute more than $2,500 in one year to a 529 plan, there is a provision for carrying over the amount above $2,500 to a future state tax deduction, but it varies by plan.

When you are ready to withdraw the money for college, you want to make sure it does not count as taxable income to you. It may seem logical to have the trustee transfer the money to your checking account, then you transfer it to the college bursar’s office, writing a single check that would cover the investment plan dollars and any additional tuition owed.

Not a good idea. At tax time, you are likely to get a form 1099-Q from the Internal Revenue Service, for payments from qualified education programs.

You may receive the 1099-Q because although the designated beneficiary of your contributions was your son or daughter, when the trustee sent the money to your account, the IRS treated it as income to you.

You may not have to pay federal taxes on the distribution, if you can show that the money was used for qualified education expenses and the amount withdrawn did not exceed the student’s qualifying education expenses. But it may be easier to avoid possible issues by having the money transferred directly from the plan to the college financial office.