Imagine a student with a full tuition scholarship and enough grants and private scholarships to cover 100% of room and board expenses. You might think that a 529 can't help this student or their parents.
You'd be wrong.
Take a taxpayer who is a resident of New Mexico. Their federal AGI is between $96,000 and $210,000 and their state income tax rate is 4.9%. New Mexico is one of four states1 that allows tax payers to deduct the full amount of 529 contributions from their taxable income. The taxpayer does not currently have a 529.
In our example, the student is a rising freshman attending a college that has the following annual cost of attendance (COA) estimate:
- Tuition: $6,304
- Room and Board: $8,560 ($4,190 for housing, $4,370 for a meal plan)
- Books and Supplies: $960
The total eligible education expenses is $15,824. We'll split this in half and take a look at only Fall 2022. We'll also add a $1,000 allowance for a computer, another 529-eligible expense, bring the total eligible education expenses for Fall 2022 to $8,912.
The student was awarded a full-tuition scholarship from the school. They also received additional grants and private scholarships that will cover all of the room, board and book expenses. Only the computer expense isn't covered.
Education Expenses
Here are the expense transactions for Fall 2022:
| Date | Transaction | Amount |
|---|---|---|
| 7/1 | 1st housing payment | -423 |
| 7/1 | 1st meal plan payment | -433 |
| 8/1 | 2nd housing payment | -423 |
| 8/1 | 2nd meal plan payment | -433 |
| 9/1 | 3rd housing payment | -423 |
| 9/1 | 3rd meal plan payment | -433 |
| 9/1 | Tuition Scholarship, credited to the student's university account | +3,152 |
| 9/1 | Grants and Private Scholarships, credited to the student's university account | +4,760 |
| 9/1 | Fall 2022 Tuition | -3,152 |
| 9/1 | Books | -480 |
| 9/1 | Computer | -1,000 |
| 10/1 | 4th housing payment | -423 |
| 10/1 | 4th meal plan payment | -433 |
| 11/1 | 5th housing payment | -423 |
| 11/1 | 5th meal plan payment | -433 |
| Net Total | -1,000 |
529 Transactions
What if the taxpaper opens an account with New Mexico's direct-sold 529 plan, and invests in the Capital Preservation Portfolio, making the following transactions:
| Date | Transaction | Amount |
|---|---|---|
| 9/1 | Open 529 with: | +2,229 |
| 9/3 | Withdraw to taxpayer: | -2,228 |
| 10/1 | Contribution: | +2,228 |
| 10/3 | Withdraw to taxpayer: | -2,228 |
| 11/1 | Contribution: | +2,228 |
| 11/3 | Withdraw to taxpayer: | -2,228 |
| 12/1 | Contribution: | +2,228 |
| 12/3 | Withdraw to taxpayer: | -2,228 |
| Final 529 Balance | +1 |
At the end of 2022, the taxpayer will have:
- $8,912 in total eligible education expenses. It doesn't matter if the expenses were paid for by scholarship, grants, or even loan money. They will still be reported as expenses on the student's 1098-T tuition statement.
- $8,913 in total contributions to a New Mexico 529. They'll report this on New Mexico's personal income tax adjustment form (PIT-ADJ), reducing their 2022 state income tax by $437.
- $8,912 in total withdrawals from the 529.
The taxpayer refrained from withdrawing the last $1 to avoid the account being closed and the hassle of reopening it in following years.
Filing 2022 Federal Taxes
The student will receive a tuition statement, form 1098-T, from the university. Box 1 will have $3,152 for tuition paid to the university. Box 5 will have $3,152 for the school's full tuition scholarship. The student will report the additional grant and scholarship money and will pay income tax on it. They may pay no federal tax if their annual income is below the standard deduction.
The room and board, books, and computer expenses aren't reported on any forms from the university. The taxpayer will need to keep receipts with their tax documentation.
Because the taxpayer paid themselves from the 529, they will receive form 1099-Q from the New Mexico 529 plan.Their total withdrawals was equal to their total education expenses, so they won't owe any penalty for excessive withdrawals. And because they kept the money in the account for such a short period of time, they won't have any taxable earnings.
The taxpayer won't qualify for the American Opportunity Tax Credit (AOTC) because all of the tuition expense was covered by scholarships.
Filing 2022 New Mexico State Taxes
When the taxpayer files their state taxes, they'll have no income to report from their 529 withdrawals. The student will pay state income tax on the scholarship and grant money that exceeded their tuition expenses.
To receive the income tax deduction for the 529 contributions, the taxpayer will report the contributions as a personal income tax adjustment on form PIT-ADJ. In 2021, it was line 14 on PIT-ADJ. Reporting the contribution will reduce their state tax bill by $437.
Total State Income Tax Savings
Because the academic year spans across two calendar years, the taxpayer was only eligible for half of the state income tax savings in 2022. However, in 2023, assuming the student attends two semesters (Winter 2023 and Fall 2023), the taxpayer could qualify for as much as $825 in 2023. You'd need to adjust that if
- the tuition rates increase
- the student spends less on room and board by living off campus
- the student had more/less book or computer expenses
Conclusion
In our example, the taxpayer didn't need to use a 529. But by using one, they can save as much as $3,325 on their state income taxes. That seems worth the hassle of opening an account, making brief contributions and withdrawals, and doing the extra tax paperwork.
If you want to learn more about New Mexico's 529 plan, there's a brochure that outlines some of the benefits. And if you enjoy legalese, you can checkout the actual tax eduction law here. Lastly, you can read the plan description for the New Mexico 529 plan, here.
Footnotes
- [1]: The four states are: Colorado, New Mexico, South Carolina and West Virginia. ↩