If NY does not adopt the new law, could someone explain how the “clawback” works. Would you just end up paying back the state tax deduction or do you also have to pay taxes on the gains and perhaps even a penalty?
NY looks like they just make you claim the non-qualified withdrawal as income for state taxes.
My state (MN) looks uglier.
In the case of a nonqualified or taxable distribution, the taxpayer is liable to state recapture of their tax benefit in the form of an additional tax for all prior years in which the benefit was claimed. The additional tax is determined by a statutory formula that multiplies the amount of the non-qualified withdrawal or taxable withdrawal by a “credit ratio” and a “subtraction ratio.”
- The "credit ratio" is a ratio of (i) two times the total amount of credits that the account owner claimed for contributions to the accounts to (ii) the total contributions in all taxable years to the account owners accounts.
- The "subtraction ratio" is the ratio of (i) the total amount of subtractions that an account owner claimed for contributions to the account owner's accounts to (ii) the total contributions in all taxable years to the account owner's accounts.
The additional tax is calculated as 50% of the product of the credit ratio multiplied by the amount of the non-qualified or taxable withdrawal, plus 10% of the product of the subtraction ratio multiplied by the amount of the non-qualified or taxable withdrawal.
However, the Minnesota additional tax will not apply to any portion of a Non-Qualified Withdrawal that is subject to the federal additional tax.
https://www.savingforcollege.com/compare_529_plans/?plan_question_ids=96&page=compare_plan_questions
I get a $500 credit for $1000 in contributions annually, so it looks it would take that back (per $1000?) plus charge a penalty. I really wanted to use the 529 this year to pay high school tuition, but definitely not worth it!
I did a bit more reading for NY state residents. I believe there are two NY state impacts (if not adopted I imagine it will be similar to the K-12 non-qualified withdrawal impact in NY State):
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The tax deduction received on past NY State returns for the withdrawal needs to be given back.
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You need to pay NY State income tax on any gains on the withdrawal in the 529 plan.
On NY’s 529 website, the following update appears. So, basically, as a NY state resident I have no idea if they will adopt or not adopt the federal law. I also have no idea if the withdrawal for a 2019 loan payment needs to take place in the next two days or not. So much fun trying to play by the rules.
"On December 20, 2019, the federal Further Consolidated Appropriations Act of 2020 was signed into law. It includes new provisions that allow 529 Plan account owners to withdraw assets to pay for certain apprenticeship programs and to pay principal and interest on qualified higher education loans for the beneficiary or any of the beneficiary’s siblings. The loan repayment provisions apply to repayments up to $10,000 per individual. These withdrawals will have no federal tax impact. It has not yet been determined whether these types of withdrawals will have New York State income tax consequences.
This Act is effective for distributions made after December 31, 2018. The new federal law continues to be evaluated as does the tax impact in New York. Additional updates will be posted on this website. Account owners are encouraged to consult a qualified tax advisor about their personal situations."
I played around with my Turbotax from last year to figure out how non-qualified withdrawals work on a state level in NY state. I believe NY state simply adds in the total 529 withdrawal that was non-qualified as income for the coming year. If I understand that correctly, the withdrawal is made up of contributions and earnings. For the contribution part, the state wants to get back the state deduction from previous years (my number 1 above). For the earnings part, the state wants to tax the non-qualified earnings (my number 2 above). Seems like a simple way to get both items by just taxing the whole withdrawal that was non-qualified in the current year.
What if you don’t need student loans, but take 10k of subsidized loans (over multiple years), deposit the proceeds in a 529 account, and pay the loans off before interest starts to accrue. In my state, there is a ~7% state tax savings for 529 deposits, or $700 for $10,000 worth of loans. You could invest the 529 funds in a savings type investment to preserve the capital and perhaps make a few percent. Obviously this would only work if you don’t need the loan proceeds for other purposes (such as paying for school…).
You have to qualify for subsidized loans, so they may not be available to you. Even if you do qualify, the subsidized portion is limited to $3500/$4500/$5500 depending on year in school (or credits earned), so it would take you 2.5 years to hit the $10k amount if you qualified for the full amount.
If you don’t need the student loans, it’s unlikely you will qualify for subsidized loans. If your need is met by other types of aid (merit/talent/school aid/federal grants), you won’t be given loans in your package. You can still take loans, but they may not be subsidized.