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What are the tax benefits?
Both types of programs are "qualified tuition programs" under Internal Revenue Code Section 529 (26 U.S.C. 529). This federal law allows earnings to be federally tax exempt beginning January 1, 2002. Additionally, most states exempt earnings from state income tax, and some states allow families to deduct the full or a partial amount of their contribution from their state income taxes.
When your dependent son or daughter uses their Section 529 state college savings plan account for college, and your family meets household income requirements, you can claim the Hope tax credit on your tax return (up to $1,500 each year for the first two years of college; up to $1,000 in Lifelong Learning credits can be claimed in subsequent years). Hope credits can only be claimed against payments for tuition and related expenses (not room and board) and there is an income limitation for eligibility of $40--50,000 for individuals and $80--100,000 for couples filing jointly.
Can I claim a federal income tax deduction based on my contributions into a Section 529 state college savings plan?
Unfortunately, there is not a federal income tax deduction for contributions into a Section 529 state college savings plan.
Can I claim a state income tax deduction based on my contributions into a Section 529 state college savings plan?
Many states offer residents a deduction on personal income tax returns for contributions made to the instate program. As a general rule, you should contact the program in your state to determine the specific state tax rules that apply to investing in a Section 529 state college savings plan. In Virginia, Virginia College Savings Plan Prepaid Tuition Contract Payments and Savings Account Contributions - If you are under the age of 70, $2,000 or the amount paid during the taxable year for each contract or a savings trust account entered into with The Virginia College Savings Plan can be claimed. Also, you may carry forward amounts over $2,000 per year until any undeducted amounts for the full purchase price have been taken. If you are over 70, you may subtract the entire amount paid during the year.
Are withdrawals from a Section 529 state college savings plan exempt from federal income tax?
As long as the withdrawal is used to pay "qualified higher education expenses", it is exempt from federal income tax.
Are withdrawals from a Section 529 state college savings plan exempt from state income tax?
Most states allow residents to participate in the 529 plans and to receive a state income tax exemption for all “qualified withdrawals”. Several states do not have an income tax, therefore they do not tax distributions from 529 plans. As a general rule, you should contact the program in your state to determine the specific state tax rules that apply to investing in a Section 529 state college savings plan. Virginia allows a credit for “any income included in federal adjusted gross income that is attributable to a distribution of benefits or a refund from the Virginia College Savings Plan (previously called the Virginia Higher Education Tuition Trust Fund), in the event of a beneficiary’s death, disability or receipt of a scholarship.”
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