Qualified State Tuition Programs

Internal Revenue Code Section 529 was added in 1996 and addresses the taxability of qualified state tuition programs. Qualified state tuition programs (QSTPs) are state-sponsored programs for prepaying higher education costs. These programs enable a person to (1) prepay tuition benefits on behalf of a beneficiary so that the beneficiary is entitled to a waiver or a payment of qualified higher education expenses, or (2) contribute to an account that is established for paying the higher education expenses of the beneficiary.

There are no income tax consequences to either the contributor to the QSTP or the designated beneficiary when contributions are made and while funds remain in the account. Distributions are included in the gross income of the distributee (beneficiary) when amounts are received or education is furnished under the QSTP, but only to the extent the amounts exceed the contributor’s contributions to the program. The income is taxed under the Section 72 annuity rules, which generally means that each distribution or educational equivalent includes both a return of capital and income. When determining the taxable amount, all QSTPs are treated as one program if the individual is a beneficiary of more than one QSTP.

Contributions to a QSTP for the benefit of someone other than the contributor are treated as taxable gifts, eligible for the annual gift tax exclusion. If a contribution exceeds the annual gift tax exclusion, the contributor can elect to spread the contribution over a five-year period. Thus, gift tax returns may need to be filed, depending on the amount of the QSTP contributions.

The expenses that can be covered under a QSTP are generally the same as those for Education IRAs. Room and board are included only if the student/beneficiary attends at least half time.

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phone @ 717-761-7210 or fax @ 717-761-7134.