Rules for Deducting 529-Plan Contributions

I’d like to contribute to a 529 college-savings plan for my 12-year-old niece for Christmas. Is my contribution tax-deductible?

Your contribution isn’t tax-deductible on your federal return, but two-thirds of the states do offer an income-tax deduction for contributions. Most require that you contribute to your own state’s plan to get the break (Arizona, Kansas, Maine, Missouri and Pennsylvania allow deductions for contributions to any state’s plan). But each state also has different rules about who can take the deduction for their contributions.

Many states, such as Ohio, let residents deduct their 529 contributions to the state’s plans even if they are not the account owner. If you live in Ohio and your niece’s parents already have an account for her in that state, for example, you can deduct up to $2,000 you contribute to her account per year (whether filing as single or jointly), and you can apply any contributions above that limit to future years’ taxes. If your niece’s parents don’t have an account for her in your state, you can open one for her yourself. There’s no limit to the number of 529 accounts that people can have for one student, and the accounts don’t need to be in the state where the student lives.

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Some states, however, only let you deduct your contribution if you are the account owner. Account owners in New York, for example, can deduct up to $5,000 per year in contributions to the state’s plan (or $10,000 if married filing jointly). If you live in a state with this rule, you may want to open an account for your niece yourself, even if her parents already have an account for her in that state, so you can qualify for the tax break.

In states that permit only account owners to take the break, nobody generally gets to take the deduction if someone other than the account owner contributes to the account. Virginia is an exception. It lets the account owner deduct the contribution even when it is made by a nonowner, says Joe Hurley of SavingforCollege.com.

The other tricky area, says Hurley, is timing the contribution so it is deductible this year. States have different rules on how they set the date of the contribution. Some use the postmark date, some use the date the money is received by the plan, and some have different cut-off rules depending on whether the contribution is made by check or electronic transfer, he says. If you’re making your contribution now, check the state’s rules to make sure it will count for your 2012 taxes.

For more information about the tax rules for 529s, see www.savingforcollege.com (opens in new tab). For our favorite plans, see our Find the Best 529 Plan tool.

See What Grandparents Should Know About Opening 529 Accounts for the impact of 529s owned by grandparents (and other nonparents, such as aunts, uncles and friends) on financial aid.

And for other ideas of financial gifts for kids, see 6 Tax-Smart Ways to Help Your Kids (or Grandkids).