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earnings tax – Can I take advantage of a 529 plan to pay student loans and declare each the state 529 deduction and the federal student loan curiosity deduction?

At first blush, this sounds prefer it could be double-dipping. But let’s check out the brand new IRS guidelines.

As identified in one other query, within the U.S. we are able to now use a Qualified Tuition Program (QTP, e.g. a Section 529 Plan) to pay student loans as a professional training expense – as much as a lifetime most of $10,000 per individual and supplied your state accepts the brand new guidelines (mine does). The newly launched IRS Publication 970 for the 2019 tax 12 months gives some good data, nevertheless it glosses over sure particulars. I even known as the IRS and tried to ask for clarification, and the rep admitted that she could not discover any solutions as a result of it is nonetheless too new. I’ll periodically attempt to get the IRS to conjure up an official reply, however I’m hoping that somebody can both shoot holes in my beneath state of affairs or present extra assist for it being legitimate.

From the 2019 Publication 970:

You can’t deduct as curiosity on a student loan any quantity paid from a
distribution of earnings constructed from a professional tuition program (QTP)
after 2018 to the extent the earnings are handled as tax free as a result of
they have been used to pay student loan curiosity.

So student loan curiosity paid from the earnings portion of a QTP distribution can not even be used for the student loan curiosity deduction – i.e. “No Double Benefit Allowed”. But it appears (from a 1099-Q) that the earnings portion on a short-term turnaround could be comparatively low (~10% of the distribution, in my case of getting a small seed steadiness). I interpret this to imply that my whole student loan curiosity paid (on the Student Loan Interest Deduction Worksheet will be calculated because the smallest of the next:

  • $2500 (most allowed)
  • reported paid student loan curiosity (from 1098-E Box 1)
  • whole student loan funds minus QTP distribution earnings (1099-Q Box 2) used to pay student loans
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Determining the final quantity requires a little bit of spreadsheet-fu however is doable to have the ability to show that I’m not double-dipping per tax legislation. This makes the next state of affairs believable:

  • Make a $333 QTP contribution, to depend as a state earnings tax deduction ($4000 max per individual for my state / 12 months)
  • Make a $500 student loan fee, the place $300 applies to curiosity and $200 applies to principal
  • Take a $333 QTP distribution a number of days later, little or no of which might be earnings
  • Include the $300 curiosity portion within the following tax season’s student loan curiosity deduction
  • Claim the complete $2500 student loan curiosity deduction from federal earnings tax (and state, they begin with my federal AGI)
  • Claim the complete $4000 QTP contribution deduction from state earnings tax
  • Not get fined for tax evasion – I’m simply saving cash by legally dancing the tax dance utilizing all of the numbers which can be reported to the IRS and the state

I understand that there might be little-to-no positive aspects from having the cash within the 529 plan for such a brief period of time (and a few danger of loss), and that is is not in any respect how 529 plans have been initially designed for use. But I’m already utilizing precisely this 529-as-a-proxy to successfully deduct my daughter’s personal faculty tuition from state earnings tax, after 529 plans have been expanded a pair years in the past to additionally enable Ok-12 tuition. I maintain a small steadiness in a conservative-growth 529 account in her identify (which has accrued some small progress as a bonus), month-to-month contribute the quantity of her tuition, and every week later withdraw the identical quantity. The account additionally has an aggressive-growth partition for her future faculty financial savings, however that is not related to the above dialogue.

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Perhaps that is authorized however prone to set off a tax audit, which could not be definitely worth the ~$100 it will achieve me on my state earnings tax return.

I’d additionally prefer to know whether or not QTPs can be utilized to pay for refinanced/consolidated student loans, however I’ll ask that query in a separate thread.

Edit: I simply received my first 1099-Q from utilizing the 529 account final 12 months on my daughter’s tuition (talked about above), and it seems like I misunderstood the earnings key phrase. It does not apply to the complete 529 distribution however particularly simply the gained/earned worth from what sits within the account. I up to date the above state of affairs accordingly.

Edit: After greater than an hour on the cellphone with an IRS rep, I a minimum of received her to acknowledge that the brand new Publication 970 is probably not sufficiently clear. Further, she had a newly-updated software that included a imprecise remark about QTP distributions with no indication of what worth to subtract from what. The name mainly ended with “I’ll recommend a clarification at our next meeting. Thank you for the feedback, but I can’t make a ruling on tax law.”

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