College Planning Q&A: 529s and Financial Aid

Morningstar Advisor Magazine August/September 2010 Issue

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College Planning Q&A: 529s and Financial Aid

by Susan T. Bart | 08-22-08

Continued from page 3.

Code sections 529 and 530 are in Subtitle A of the Internal Revenue Code. Code section 501(c) exempts a 501(c)(3) from taxation under Subtitle A, and I see no reason why that would include taxes imposed under Code section 529(c)(3)(A) but not taxes imposed under Code section 529(c)(6) and section 530(d)(4).

If instead the charity changed the beneficiary to itself or to a scholarship recipient, who would not be a member of the family of the old beneficiary, the change of beneficiary would be treated as a nonqualified distribution, but under the above analysis no tax would be paid. In addition, there is potentially another argument for avoiding tax on such a change of beneficiary. Section 529(e)(1) defines "designated beneficiary" to include:

(C) in the case of an interest in a qualified tuition program purchased by ... an organization described in section 501(c)(3) and exempt from taxation under section 501(a) as part of a scholarship program operated by such ... organization, the individual receiving such interest as a scholarship.

Section 529(e)(1)(C) appears intended to permit a charity to invest in a 529 savings account as part of a scholarship program without designating a beneficiary (or perhaps designating itself) until it actually awards a scholarship, at which time it would name the scholarship recipient as the beneficiary of the appropriate portion of the account. Thus the normal rules about designating and changing a beneficiary do not apply to charities. An argument can be made that it would be consistent with this intent to allow a charity to receive a "leftover" 529 account and revoke the old beneficiary designation without the imposition of any income tax or additional tax.

To comply with certain Treasury regulations, we state that (i) this article is written to support the promotion and marketing of the transactions or matters addressed herein, (ii) this article is not intended or written to be used, and cannot be used, by any person for the purpose of avoiding U.S. federal tax penalties that may be imposed on such person and (iii) each taxpayer should seek advice based on the taxpayer's particular circumstances from an independent tax advisor.
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Susan T. Bart is a partner in the Private Clients, Trusts & Estates Group at Sidley Austin LLP in its Chicago office, where her practice includes estate planning, estate and trust administration, and fiduciary counsel. She has written two books, including Education Planning and Gifts to Minors published by Illinois Institute for Continuing Legal Education (iicle.com), which extensively discusses 529 plans.

She is the author of Education Planning and Gifts to Minors 2004 Edition. She is a frequent speaker on trust and estate topics in general and Section 529 college savings plans in particular.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar.

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