Understand the Tax Benefits of 529 Plans
When you invest in Bright Start, any earnings grow federal-tax free, and are tax-free when they’re withdrawn for qualified college expenses. If you live in Illinois, you also get some added state tax benefits. For Illinois taxpayers contributions to Bright Start are tax deductible. You’ll enjoy a deduction of up to $10,000 per year ($20,000 if married and filing jointly) and you pay no state income tax on earnings and withdrawals that are used for qualified college expenses1. You can also deduct the contribution portion (but not earnings) of rollovers from other state 529 plans. December 31 deadline for contributions. To be deductible for a calendar year you must make the contribution before the end of that given calendar year. Contributions postmarked on or before December 31, should be treated as having been made in the year in which it was sent.
Keep in mind – if funds are spent on non-qualified expenses, you’ll pay taxes on your earnings, plus an additional 10% federal tax. And the amount of any deduction previously taken for Illinois income tax purposes is subject to recapture when withdrawn for non-qualified purposes or if assets are rolled over to a non-Illinois 529 plan. Other states offer similar benefits to their residents, so if you live outside of Illinois you’ll want to understand your own home state plan and its benefits and features.
The current gift tax annual exclusion is $15,000 per year ($30,000 for a married contributor electing to split gifts).
In addition, if a donor’s total Contributions to Accounts for a Beneficiary in a single year exceed the annual exclusion for such year, the donor may elect to treat Contributions, up to five times the annual exclusion, as having been made ratably over a five-year period. Consequently, a single donor may contribute up to $75,000 in a single year without incurring federal gift tax, so long as the donor makes no other gifts to the same Beneficiary during the calendar year in which the Contribution is made or any of the next four calendar years.
An election to have the contribution taken into account ratably over a five-year period must be made by the donor on a United States Gift Tax Return Form 709.
Invest Your Tax Refund
If you will be receiving a federal or state tax refund, consider investing it into your Bright Start 529 account. Both your federal and state tax returns allow you to deposit all or a portion of any tax refund.
Here is the information you will need when completing the “Refund – Direct Deposit” section of your federal and/or Illinois tax returns. Please use the following bank information:
Routing Number: 10 491 0795
Type of Account: Savings
Account Number: 4529 followed by your Bright Start 10-digit account number.
Qualified Higher Education Expenses (Source: IRS Publication 970 – January 2021)
These are expenses related to enrollment or attendance at an eligible postsecondary school. As shown in the following list, to be qualified, some of the expenses must be required by the school and some must be incurred by students who are enrolled at least half-time, defined later.
- The following expenses must be required for enrollment or attendance of a designated beneficiary at an eligible postsecondary school.
- Tuition and fees.
- Books, supplies, and equipment.
- Expenses for special needs services needed by a special needs beneficiary must be incurred in connection with enrollment or attendance at an eligible postsecondary school.
- Expenses for room and board must be incurred by students who are enrolled at least half-time. The expense for room and board qualifies only to the extent that it isn’t more than the greater of the following two amounts.
- The allowance for room and board, as determined by the school, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.
The actual amount charged if the student is residing in housing owned or operated by the school.
You may need to contact the eligible educational institution for qualified room and board costs.
- The purchase of computer or peripheral equipment, computer software, or Internet access and related services, if it’s to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible postsecondary school. (This doesn’t include expenses for computer software for sports, games, or hobbies unless the software is predominantly educational in nature.)
- The expenses for fees, books, supplies, and equipment required for the designated beneficiary’s participation in an apprenticeship program registered and certified with the Secretary of Labor under section 1 of the National Apprenticeship Act.
- No more than $10,000 paid as principal or interest on qualified student loans of the designated beneficiary or the designated beneficiary’s sibling. A sibling includes a brother, sister, stepbrother, or stepsister. For purposes of the $10,000 limitation, amounts treated as a qualified higher education expense for the loans of a sibling are taken into account for the sibling and not for the designated beneficiary. You can’t deduct as interest on a student loan (see chapter 4) any amount paid from a distribution of earnings from a QTP after 2018 to the extent the earnings are treated as tax free because they were used to pay student loan interest.
Half-time student. A student is enrolled “at least half-time” if he or she is enrolled for at least half the full-time academic work load for the course of study the student is pursuing, as determined under the standards of the school where the student is enrolled.
Qualified Elementary and Secondary Education Expenses
These are expenses for no more than $10,000 of tuition, incurred by a designated beneficiary, in connection with enrollment or attendance at an eligible elementary or secondary school.
*CAUTION – Illinois Qualified Expenses do not include expenses for:
- tuition in connection with the Beneficiary’s enrollment or attendance at an elementary or secondary public, private, or religious school. The amount of cash distributions for such expenses from all 529 qualified tuition programs with respect to a Beneficiary shall, in the aggregate, not exceed $10,000 during the taxable year.
- If a withdrawal is made for such purposes it may be a Federal Qualified Withdrawal and not be included in income for federal and Illinois purposes, but if an Illinois income tax deduction was previously claimed for Contributions to the Account all or part of that deduction may be added back to income for Illinois income tax purposes.
Please consult with your tax advisor.
2020 Tax Information
Find out where to find your 2020 Tax Form, where to get the full year 2020 contribution amount for taxes and other tax-related questions. Read More >
Withdrawal Reporting Form
Did you request a withdrawal from your Bright Start 529 account in 2021? If so, you will receive IRS Form 1099-Q (mailed by Bright Start by January 31, 2022). The 1099-Q is an IRS tax form showing the total amount of all withdrawals requested to the same payee as well as the principal and earnings portions of those withdrawals.1The Account Owner will receive the 1099-Q if the check was payable to the Account Owner. The Beneficiary receives the 1099-Q for any withdrawals paid to the Beneficiary or to the school. We recommend that you keep the receipts and documentation of your college expenses with your tax paperwork in the event there are any questions about the amount you have withdrawn. You should discuss any tax reporting requirements with your tax professional.
Other Important Tax Information and Considerations
The tax benefits afforded to 529 plans must be coordinated with other programs designed to provide tax benefits for meeting Qualified Higher Education Expenses to avoid the duplication of such benefits. You should consult with a qualified tax advisor with respect to the various education benefits.
Taxable Portion of a Distribution
The part of a distribution representing the amount paid or contributed to a qualified tuition program doesn’t have to be included as income. This is a return of the investment in the plan.
The designated Beneficiary generally doesn’t have to include in income any earnings distributed from a qualified tuition program if the total distribution is less than or equal to adjusted qualified education expenses.
To determine if your total distributions for the year are greater or less than the amount of qualified education expenses, you must compare the total of all qualified tuition program distributions for the tax year to the adjusted qualified education expenses. Adjusted qualified education expenses are the total qualified education expenses reduced by any tax-free educational assistance. Tax-free educational assistance includes: the tax-free part of scholarships and fellowship grants; veterans’ educational assistance; the tax-free part of Pell grants; employer-provided educational assistance; and any other non-taxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.
Coordination with American Opportunity and Lifetime Learning Credits
An American opportunity or lifetime learning credit can be claimed in the same year the Beneficiary takes a tax-free distribution from a qualified tuition program as long as the same expenses aren’t used for both benefits. This means that after the beneficiary reduces qualified education expenses by tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit.
Coordination with Coverdell Education Savings Account Distributions
If a designated beneficiary receives distributions from both a qualified tuition program and a Coverdell Education Savings Account in the same year and the total of these distributions is more than the Beneficiary’s adjusted qualified higher education expenses, the expenses must be allocated between the distributions.
Coordination with Tuition and Fees Deduction
A tuition and fees deduction can be claimed in the same year the beneficiary takes a tax-free distribution from a qualified tuition program, as long as the same expenses aren’t used for both benefits.
Recontribution of Refunded Amounts
If a student receives a refund of qualified education expenses that were treated as paid by a qualified tuition program distribution, the student can recontribute these amounts into any qualified tuition program for which they are the beneficiary within 60 days after the date of the refund to avoid the need to figure the taxable part of the qualified tuition program distribution. Please consult with your tax professional regarding the proper reporting and record retention requirements.
- Illinois Department of Revenue
- IRS Publication 970
- IRS: Education Credits – American Opportunity Tax Credit and Lifetime Learning Credit
Internal Revenue Service Circular 230 Notice
Although our professionals provide information about Bright Start, they cannot provide tax advice. The information, including all linked pages and documents, on the Bright Start website is not intended to be tax advice and cannot be used to avoid any tax penalties. Union Bank & Trust, and its affiliates, and its associates do not provide legal or tax advice. Any tax-related discussion, including all linked pages and documents, contained on the Bright Start website is not intended or written to be used, and cannot be used, for the purpose of: 1) avoiding any tax penalties that may be imposed under the Internal Revenue Code or applicable state or local tax law provisions; or 2) promoting, marketing, or recommending to any person any transaction or matter addressed herein. You should consult your own tax advisor.