Qualified tuition programs

By Frank Minuti, CPA

Qualified tuition programs (QTP) also called "Section 529 Plans" are accounts that are set up to be used to fund qualified higher education expenses of a designated beneficiary. There are two types of QTPs:

1. Prepaid programs where the contributions are used to purchase tuition credits for a designated beneficiary, and
2. Savings account plans where the contributions are invested to be withdrawn to pay the qualified higher education expenses are they are incurred.

If a family has more than one child, a separate QTP plan is set up for each child (beneficiary). The benefits may be transferred from one beneficiary to another without incurring any tax consequence.

Qualified higher education expenses include tuition, fees, books, supplies, reasonable costs for room and board and expenses of a special needs beneficiary. Also included for federal but not for California are computer equipment, software and internet access as long as the use is for primarily educational purposes.

A taxpayer (donor) can contribute up to $13,000 ($26,000 in the case of a married couple) annually to each QTP without using up any of their lifetime exclusion from estate tax which is $5,000,000 for 2011 and 2012. If the donor makes any additional gifts to the beneficiary of the QTP during the year the donor must file gift tax returns. If a taxpayer wants to contribute more than $13,000 to a QTP plan in one year they are allowed to contribute up to $65,000 ($130,000 in the case of a married couple) in one tax year and count it as a gift made ratably over five years beginning in the year of the gift. A gift tax return must be filed in the year of the gift if the gift is over $13,000.

The donor does not receive any income tax benefits from making contribution(s) to the QTP plan but the dollars are not included in the estate of the donor. The primary benefits are that the dollars grow income tax free inside the plan.

A 10% federal and a 2.5% California penalty is applied to distributions that are not used to fund qualified higher education expenses unless the distribution is due to the death or disability of the beneficiary. The purchase of a computer would not be subject to the federal penalty but would be subject to the California penalty.