As a follow up to our last piece on 529 plans, several astute readers asked the same follow up question: does my state have to approve the changes to the federal law before I can use 529 money for K-12 private or parochial school? The short answer is no. Under the Supremacy Clause of the United States Constitution, federal laws supersede state laws. A 529 plan is a special provision of the Internal Revenue Code, which is federal tax law. Thus, no state (even CT!) can prevent you from using 529 money for K-12 Education.
State Tax Deduction
However, some states now give you a state tax deduction for contributing to a 529 plan. This deduction is state law, so your state can take it away if they disagree with the new federal law changes. Some states, like Iowa, have specific language in their state tax laws that only allow for a tax deduction for 529 plan if they are used for college expenses. That is a key difference from the federal terminology “Qualified Education Expenses,” which was expanded in the recent Tax Cuts and Jobs Act. Here in Connecticut, our current state tax law does allow for the deduction to be used for K-12 education because the deduction is allowed for any 529 contributions that are later used for “qualified education expenses.” In fact Governor Malloy’s office acknowledged this publicly in their recent budget proposal. However, that does not mean it cannot be changed. We are monitoring some of the debate in Hartford over the new 529 rules. Some legislatures are concerned that these rules are giving an unfair tax break to parents of private and parochial school children. We will update the Rocco & Associates community if any changes are made in the upcoming months, although nothing has been proposed as of yet.
The bottom line, your state cannot prevent you from using the funds for K-12 education, and they cannot prevent the funds from accumulating tax free (the number one benefit of a 529 plan). However, they can prevent you from getting a state tax deduction on your contribution. While not ideal, even without a deduction a 529 plan is still one of the most tax efficient ways to save for college. Don’t hesitate to reach out to learn more!
Prior to investing in a 529 Plan investors should consider whether the investor's or designated beneficiary's home state offers any state tax or other state benefits such as financial aid, scholarship funds, and protection from creditors that are only available for investments in such state's qualified tuition program. Withdrawals used for qualified expenses are federally tax free. Tax treatment at the state level may vary. Please consult with your tax advisor before investing.
This information is not intended to be a substitute for specific individualized tax advice. We suggest that you discuss your specific tax issues with a qualified tax advisor.