If you are one of those unlucky moms or dads who had to face heavy losses from the 529 savings plan that you invested in, with your child’s college education in mind, read ahead to find out if you can just possibly bail yourself out by deducting those losses from your taxes. Words of caution straightaway though, don’t get your hopes too high because the IRS has not painted a clear picture on this and the rules are quite a bit hazy.
As mentioned in Publication 970, which concerns the tax benefits associated with education, the IRS has classified the closing down of a loser 529 saving plan account as a tax-deductible loss. But then, that is where the instructions stop; there is no further official or unofficial clarity on what conditions need to be met and in what cases a loser 529 account can be deducted.
Let us try to throw some light on the conditions that will be taken into account while considering your 529 account losses for tax deduction.
First of all, all the holdings associated with all the 529 savings accounts that you own for a particular beneficiary (your son/daughter) under the plan of a certain state, need to be liquidated. On liquidation, the proceeds will not go to the actual beneficiary, i.e., your child, but rather to you, as you are the owner of the account.
The above mentioned liquidation proceeds must be less than the total basis amount (this is equal to the amount of money that is contributed by you to the savings plan, with the general assumption that you have not made any withdrawals from your contribution) in the 529 account(s). To illustrate, if you have a single 529 savings account for your son, and have never withdrawn any money from it, and the money you receive from shutting down that account is less than the money originally contributed towards it by you, then, you have yourself a potentially deductible 529 savings account loss.
Wait a minute, its not over yet, there are more hurdles in your way to collecting those tax savings! The IRS classifies a 529 savings account loss as a Miscellaneous Itemized Deduction. So, it is clubbed along with all other miscellaneous deductions, and, only if this total miscellaneous deduction amount is greater than 2% of your Adjusted Gross Income (AGI), is it considered tax deductible. Next hurdle coming up; let’s say you clear the 2% AGI criterion, even then, a phase-out rule for high income individuals will ensure that you lose some of your miscellaneous deductions write-off amount. The biggest blow of them all, if you are a victim of Alternative Minimum Tax (AMT), which says a big no to this kind of a deduction, you can bid your 529 loss deduction hopes goodbye!
In conclusion, closing down a loser 529 accounts might initially seem like a good plan, but it involves getting past quite a few IRS hurdles and the actual benefit that you receive might not be as much as you hoped for. Liquidation of your 529 account(s) is only a viable option if your primary aim is to get your money back and tax savings are just an added bonus on top of that.