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Today's lesson: 529 plans and you

Careful -- that laptop may not qualify under IRS rules

August 10, 2008|James S. Granelli | Times Staff Writer

Your 18-year-old is on the way to college, and you're tapping into that stash of money you've accumulated over the years in one of those tax-free college savings plans.
But if you want to pay for more than room, board, tuition and books, you'd better check with the federal revenooers first. Buy the wrong thing and you could be hit with taxes and a 10% penalty on your earnings.
Want to use the money to buy a laptop computer for the kid? Maybe you can, maybe not. Want to pay off part of a student loan taken the year before? Forget about it. Got enough for a down payment on a used car so college boy can come home once in a while? You've got to be kidding. Even transportation at school isn't covered.

Since 1996, Section 529 of the Internal Revenue Code has allowed parents, grandparents and others to set aside money in special state-sponsored savings plans for a child's "qualified higher education expenses." A major attraction, of course, is that all the interest earned can be spent tax free -- as long as it's on qualified expenses.

So what are qualified expenses? The code defines them as "tuition, fees, books, supplies, and equipment required for the enrollment or attendance" at school. Pretty black-and-white, for the most part. But needs change every year, and the law stays the same.

What constitutes "supplies" and what "equipment" is "required for the enrollment or attendance" at school?

"One of the questions we get asked the most is, 'Can I use the money to buy a laptop?' " said Joe Hurley, founder of, one of the top Internet sites for information about tax-free savings plans.

Using 529 funds to buy a laptop is one of the squishiest of issues and one ripe for congressional action.

For now, the answer depends on whether a class or the school itself requires students to have computers. An architecture student who has to use modeling software might be able to justify spending 529 money to buy a laptop. But a business major? Probably not.

James Carlin wasn't going to take any chances. For the last two years, the Manhattan Beach resident has been pulling money out of a college account for his son, Jeffrey, a business and accounting major at Cal Poly San Luis Obispo.

Even before his son graduated from high school, though, Carlin had decided that he wasn't about to test the law by using the funds to purchase a computer. Luckily for Jeffrey, he got a laptop as a graduation gift.

"The lion's share of the funds goes for tuition, books and room and board," said Carlin, a partner at the Santa Monica accounting firm Holthouse, Carlin & Van Trigt. He expects that Jeffrey will drain the account on those kinds of expenses.

Where it becomes a bit dicier, however, is figuring out qualified 529 expenses while living off campus and buying your own food and such school supplies as notebooks, pens and paper.

The room and board expense, for instance, can't be greater than what the school specifies as its room and board costs -- typically what is charged for on-campus housing and meal plans.

And then there's the problem of managing receipts, especially for out-of-pocket expenses. After all, when the IRS comes calling, you need the receipts to justify withdrawals from the fund.

"I do my best to keep track of things," Jeffrey Carlin said. "But there have been times when I've run into a market quickly to grab a few things and didn't keep the receipts."

The 529 industry is booming. The number of plans rose nearly fivefold since 2001 and the total value of funds shot up tenfold to $130 billion, according to trade group College Savings Plans Network. The organization, which represents state governments, universities and financial companies, expects an additional $70 billion to $100 billion to flow into 529 plans over the next five years.

Each state and the District of Columbia sponsor at least one 529 plan and use investment houses or management firms to administer them. California has two categories with a number of plans operated by Fidelity Investments.

Some states -- but not California -- offer deductions on state income taxes for contributions to 529 plans, and the industry is pushing Congress to adopt the idea for federal income tax laws.

Anyone can set up an account with just about any state fund and use the money at nearly any public or private school nationwide -- even at many foreign universities.

"These funds are mainly geared for typical college expenses," said Kevin McMullen, chairman of the nonprofit College Savings Foundation, a clearinghouse for 529 plans, the most popular type of college savings account.

Qualified expenses

Still, the industry built up to promote 529 plans wants a few changes.

The College Savings Plans Network, which lobbies for 529 plan administrators and state education officials, is asking Congress for an amendment to include computers, Internet access and educational software as specified qualified expenses.

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