The Protecting Americans from Tax Hikes (PATH) Act provided an important update to 529 plans, retroactive to the beginning of 2015. However, since Congress didn’t get around to passing the legislation until the mid-December, 529 plan administrators were left in a bind to adjust their software to issue correct 1099-Qs that reflect the new rules. Fortunately for 529 plan administrators, the IRS has promised not to impose penalties for earnings computations that do not reflect the new law.
Prior to the Economic Growth and Tax Relief Reconciliation Act (EGTRRA) of 2001, the earnings portion of 529 withdrawals, even when used to pay for college, was taxable income to the beneficiary. Because of this, all 529 savings accounts in one state with the same account owner and beneficiary had to be aggregated for the purposes of calculating of earnings reported on Form 1099-Q when withdrawals were made. Even after EGTRRA made distributions for qualified education expenses non-taxable, the distribution aggregation requirements remained for any distributions in excess of the student’s qualified higher education expenses.
The issue with the remaining distribution aggregation law is it required cumbersome compliance and reporting requirements for plan providers with almost zero benefit to anyone else. The aggregation requirements applied to plan contribution maximums as well as distributions, so parents who wished to put more money into a 529 plan might open one in another state to get around the limits, but there was no reason to open another plan in the same state for the same beneficiary.
However, even though the proposed legislation to eliminate distribution aggregation requirements first popped up in January of 2015 with H.R. 529, a bipartisan piece of legislation drafted by Rep. Lynne Jenkins (R-KS) and Rep. Ron Kind (D-WI) in response to President Obama’s short-lived proposal to eliminate the federal tax benefit of 529 plans, it didn’t become law until PATH was enacted in mid-December 2015.