Too Much Ado Over a Tax Deduction: College Savings Deduction Eliminated in NC
Unless the North Carolina General assembly reinstates the deduction, taxpayers will not be able to deduct their contributions to the North Carolina 529 college savings program next year. When our legislature reduced our tax rates, they also eliminated a host of deductions starting in 2014. So this year, filers can still deduct up to a $2,500 for individuals and $5,000 for joint filers if they contribute to a NC 529 plan for a child, grandchild, or other beneficiary.
John Frank of the News & Observer reported on Saturday that some investors are thinking that 2013 will be the last year they create or contribute to the NC 529 plan because the tax deduction is going away. Before I explain why this would be a bad decision, I need to provide some disclosure. While I spend most of time drawing and writing, I still consult for the College Foundation of North Carolina on the investment options in their plan. Further disclosure: I have also set up a 529 account under the North Carolina plan. However this blog post has nothing to do with my work for CFNC or the account I set up.
According to Mr. Frank’s reporting, 38,000 taxpayers saved $6.1 million in 2011 by taking the deduction. In other words, taxpayers saved an average of $160 by contributing to a NC 529 plan. The savings is actually smaller, because the state deduction increased their federal tax liability by about $30. And if the General Assembly hadn’t eliminated the tax deduction, its value would have fallen anyway because the maximum tax rate in NC will drop from 7.75% to 6%.
For those of you contemplating the maximum deduction of $5,000, by my back-of-the-envelope calculation, the current deduction is worth about $390 (or $250 after federal taxes). Under the new rates, the deduction would have been worth $300 (or $210 after federal taxes). The actual savings vary based on your effective federal and state tax rates.
The main tax benefit of 529 programs, whether you use NC’s program or some other state’s, is that the gains are tax deferred for federal and NC income tax, and distributions to your child or grandchild for college expenses are tax-free. Moreover, these programs are easy to set up, fund, and track. While the deduction was a nice additional inducement, the main benefits of the NC529 remain valid. Those who decide not to use the 529 program in future years are acting like people who stop ordering chocolate sundaes because there’s no longer a cherry on top.
Tax deductions tend to have a powerful hold on people. However, it’s important to remember why you’re making the investment in the first place (in this case to save for college) and the real value of the expiring deduction (in this instance relatively small). If you are considering a college savings plan or an additional contribution to an existing account in North Carolina, I have two simple messages. First, the deduction is available for this tax year. Second, don’t let the elimination of the tax deduction in future year’s blind you to the benefits of college savings through a 529 plan.