A 529 deduction is a deduction that is based on the college savings plan known as a 529 savings plan. This deduction is calculated from money donated to the plan by the person who opened and maintains it, known as the donor. The only deductions that are applicable to a 529 plan are the ones given by the state in which the donor creates the account based on funds contributed, or as a result of losses the account experiences over time. A deduction for losses can be applied to federal and state taxes.
Named after section 529 of the Internal Revenue Service (IRS) code, the 529 plan offers an essentially tax-free way to pay for higher education. The plans are set up by a donor for a beneficiary to attend school. Funds that are contributed to a 529, depending on the particulars of the plan, can cover tuition, room and board, books, and equipment, as long as it used in conjunction with attendance at an eligible institution, usually a university or college, and are not taxed.
Many reasons exist to consider using a 529 plan. In addition to the deductions available from some states for contributions made to the fund, any interest made from the account is tax free as are any payouts made to the beneficiary for use with school. If the funds are not used by the beneficiary, the account can be rolled over to another eligible beneficiary without a penalty. The plans are pretty much hands-off, as they are handled by the state or learning facility, and the amount of money that can be put in is usually rather high, typically up to several hundred thousands of dollars. Donors can also withdraw the funds at any time, but there will be a penalty assessed.
The main 529 deduction available is given by the state in which the donor lives. It typically only applies if the state in which the donor lives in is the same state where they open the account. Not all states give the 529 deduction, and the amount and particulars will differ from state to state. The deduction will only be given to the donor, not the beneficiary.
In some cases, if the account loses money a 529 deduction could apply if the account is closed and the losses taken as an itemized deduction. This can be tricky, however, as the law is not very clear on how this is handled. Another disadvantage is that any deductions applied to the state taxes may have to be given back if the loss deduction is claimed.