Always Read the Instructions. Carefully!
Question:
How do I Best Report a Large Increase in Income FAQ?
My income is going to increase dramatically this year.
I think I’m going to do a 529 with some of my windfall. At least that gets me out of the state tax. Do you have any other advice?
Answer: The 529 College Savings Plan Contribution has a subtlety that’s easy to miss unless you’re a careful reader.
Here’s the State’s instructions:
Payments or contributions you made during 20XX to a qualified state tuition program administered by CollegeInvest can be deducted, but only to the extent they are included in federal taxable income.
See FYI 44 (State Tuition Program Contribution Program).
The second part of the sentence is what many paid-preparers and self-preparers miss. It means that a taxpayer can only deduct an amount related to a 529 College Savings Plan if it was taxable on the Federal individual income tax return. This occurs generally in only two instances:
• The parent receives a distribution due to account closure (taxed on earnings, not principal).
• A portion of the distribution was not used for postsecondary education purposes (taxed on applicable pro-rated earnings).
Form 1099-Q for payments from qualified education programs (529 College Savings Plan) is issued for all withdrawals. It reports the following to the Internal Revenue Service – gross distribution, earnings, basis, and whether or not the recipient is the designated beneficiary. Contributions to 529 College Savings Plans are never deductible while withdrawals of prior contribution are not taxable, just the allocated earnings if not used for postsecondary purposes.
Further, a Colorado resident can only deduct the earnings taxed at the Federal level if the 529 College Savings Plan was with Colorado CollegeInvest.
Unfortunately most people don’t read instructions and thus, many Coloradoans mistakenly report and deduct amounts contributed annually on Form 104, Line 10 – Tuition Program Contribution.
