Generation to Generation

One of the best ways for parents and grandparents to put money aside for the college educations of their children and grandchildren is through tax-favored vehicles authorized by Internal Revenue Code section 529 called “529 Savings Accounts.” During this era of ever-increasing college costs, when you first create a 529 Savings Account for a child, it is hard to fathom that – years down the line – the account could have any money left over after all the tuition bills are paid. But it can happen. The child’s college degree is earned in three years, not four; the undergraduate experience proves disappointing; or the graduate school tuition is covered by an employer instead. Whatever the reason, an overfunded 529 Savings Account can still lead to a good financial outcome if you know your options.

In a press release and IRS Notice (Notice 2018-54) issued Wednesday, May 23^rd, the IRS warned taxpayers to be wary of state efforts to circumvent new federal limits on deductions for state and local taxes.  Under the recent tax overhaul, deductions for state and local taxes (including property taxes) are capped at $10,000.  This cap is particularly detrimental for residents of states with high property taxes and/or state and local income taxes (for example, California, Massachusetts, New Jersey, New York and Connecticut). 

To mitigate the adverse impact of the new $10,000 cap on state and local taxes, states have been considering alternative methods to raise revenue that would avoid the cap.  New Jersey Governor Phil Murphy and New York Governor Andrew Cuomo have both signed legislation permitting local governments to set up charitable organizations that can accept property tax payments as donations (which could be deductible, without limitation, against federal taxable income). 

Notice 2018-54 announces that the Department of Treasury and the IRS intend to propose regulations regarding the SALT deduction cap, and signals their view that tax payments in excess of the cap (regardless of how structured) are not deductible.  In particular, the Notice highlights the approach taken by New York and New Jersey (structuring tax payments to allow taxpayers to characterize the payments as deductible charitable contributions), and warns that federal law, not state law, controls the proper characterization of payments for federal income tax purposes.

For more information on federal tax reform’s impact on individuals see our earlier Legal Advisory, issued April 17, 2018, titled “Practical Insights on Tax Reform: Impact on Individuals”.