SPRINGFIELD — Illinois families with Bright Start or Bright Directions college savings plans will not get a break on their state taxes if they use those accounts to pay for private K-12 tuition, Treasurer Mike Frerichs said Thursday.
And if they try to claim that deduction, they could potentially face a tax penalty from the state, he further warned.
The new federal tax law includes a provision allowing families with so-called 529 college savings plans, originally only for higher education expenses like tuition, fees and books, to use those tax-deductible funds for private K-12 tuition starting this year.
“Our analysis concludes that families who use Bright Start or Bright Directions money on elementary or high school expenses and then cite those expenditures when seeking tax relief will be in conflict with state law and could incur tax penalties if audited by state authorities,” Frerichs said.
The Illinois Department of Revenue concurred with the treasurer’s analysis, saying “the Illinois plans only allow expenditures on post-secondary education without penalty,” and that “In order to expand the definition of qualified expenditures, section 16.5 of the State Treasurer Act would need to be amended.”
The idea behind Illinois’ 529 savings programs, Bright State and Bright Directions, is to incentivize state taxpayers to save money for themselves or loved ones to attend college. The plans have been popular as they are not subject to federal income taxes and contributions are tax-deductible up to $10,000 for an individual or $20,000 for a married couple on state income taxes. And when it comes time for college, withdrawals from these accounts are exempt from state and federal taxes.
According to Frerichs, more than 450,000 accounts are open in Illinois, with about $9 billion invested in them.
“The whole idea on the state tax deduction was to incentivize saving for college,” Frerichs said. “It was not to incentivize private education.”
Though Illinois residents with plans will be able to use them for private K-12 tuition, they will have to pay the regular 4.95 state income tax rate on that cash. But, many, namely the wealthy, still stand to benefit from escaping federal taxes.
“Anytime you put a benefit in the code, the wealthy most likely will use it more aggressively unless the benefit is phased out at higher income levels — as is the case with many benefits put in the tax law,” said DePaul University professor Ron Marcuson, a tax expert. “I have not analyzed all aspects of Section 529 plans but it does not appear the benefit is phased out as the taxpayer’s income increases.”
However, Frerichs is worried that the confusion caused by conflicting state and federal policies will lead policyholders to write off that expense as a state tax deduction.
The Democratic treasurer said such a write-off, in addition to violating Illinois tax code, is in conflict with the spirit of the program, to save money long-term for college. Instead, Frerichs said the new federal provision opens up opportunities he likened to money laundering.
“Now you could see someone who’s already sending their kid to private school, has a $10,000 tuition bill; instead of giving $10,000 directly to the school, they can put it into a 529 account and then next day, write a check from their 529 account to a school,” Frerichs said. “They’ve not actually saved any money and they didn’t invest in it, they didn’t earn any interest off it. It’s just basically money laundering, it’s a pass-through for tax avoidance.”
If this were to occur, Frerichs said it would could have a negative impact on tax revenue for the state.
“There’s uncertainty of what’s going to happen if they write a check,” Frerichs said. “We want them to know that there are potential penalties out there for doing this, but our hope also is that the General Assembly and the governor will provide some clarity on what they would like.”
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January 18, 2018 at 07:09PM