Tax-Smart Ways to Contribute to a 529 College-Savings Fund

I want to contribute some money to my grandson's 529 college-savings fund as one of his Christmas presents. Can I deduct my contributions on my state income taxes?

Contributing to your grandson's 529 can be a great gift for his future, and you may be able to get a tax break, too, depending on where you both live.

Two-thirds of the states offer an income-tax deduction for contributions. Most states require you to contribute to your home state's 529 plan in order to get the tax break, but five states -- Arizona, Kansas, Maine, Missouri and Pennsylvania -- allow a deduction for contributions made to any state's plan.

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And states have different rules about who can qualify for the tax break. In some states, such as New York, you can take the deduction only if you're the owner of the account. In other states, such as Connecticut and Kansas, anyone who contributes can claim a deduction, even if they don't own the account.

If your grandson's parents already have an account in your state, and if the state allows contributors other than account owners to take the deduction, then you're all set. If their account is in a state that doesn't offer a tax break for others' contributions, but your state does offer a deduction, then you can open a new 529 account for your grandson in your own state and benefit from the tax break. There's no limit on the number of 529 accounts that can be opened for one child.

Also be aware that some states limit your deduction for the year. New York, for example, has a $5,000 limit on deductions per year by an individual, or up to $10,000 per year for a married couple filing jointly. Others, such as Virginia, limit your annual write-off but let you extend the tax break over several years. You can deduct up to $4,000 from Virginia's taxes each year, and then can carry forward any excess contributions to future years (if you contribute $5,000 in one year, for example, you can deduct $4,000 in that year and the remaining $1,000 the next year). And special rules may help some grandparents: That annual limit is waived in Virginia for people who are 70 or older. They can deduct their full contributions -- even above the $4,000 limit -- in the year they make them.

You may want to act quickly to benefit from the tax break this year. Most states require you to make your contribution by December 31, 2011, to qualify for the 2011 tax deduction. For more information about each state's tax breaks, deadlines and rules for 529s, go to Savingforcollege.com, click on "compare plans," and focus on the tax section.

If you are contributing a big lump sum, try to keep the total below $65,000 for the year (or $130,000 for a married couple) so that you don't have to file a gift-tax return. Although normally you are limited to giving away no more than $13,000 per year per recipient (married couples can give up to $26,000 per year to a single recipient) without filing a federal gift-tax return, there is a special exception that allows you to contribute up to five years' worth of the gift-tax exclusion amount to a 529 plan -- as long as you don't give any additional money to that individual within the five-year period.