Group Seeks Guidance on Tuition Programs

January 20, 2016

Victoria Judson, Associate Chief Counsel (TEGE)
and
Janine Cook, Deputy Associate Chief Counsel (TEGE)
Office of the Chief Counsel
Internal Revenue Service
1111 Constitution Avenue, N.W.
Washington, DC 20224

Dear Ms. Judson and Ms. Cook:

The College Savings Plans Network (CSPN), on behalf of its members is writing to you in response to the Protecting Americans from Tax Hikes Act (“PATH Act”) that was signed into law in December 2015. The PATH Act included important enhancements to Section 529 qualified tuition programs (“529 Programs”) that the 529 industry sought for many years. We are seeking guidance from the Treasury Department regarding a certain provision concerning the treatment of the re-contribution of refunded withdrawals under 26 U.S.C. § 529(c)(3)(D) as modified by the PATH Act.

Established to make higher education more financially attainable, CSPN is a national non-profit association and the leading objective source of information about 529 Plans. An affiliate of the National Association of State Treasurers (NAST), CSPN works with its members to enhance 529 Programs and assist American families in planning and saving for higher education. CSPN members include state officials and state-sponsored 529 Programs, as well as program managers, investment managers, and many organizations providing services to 529 Programs, including legal, accounting and general consulting services.

State sponsors and program managers of 529 Programs believe there is some lack of clarity regarding the treatment of re-contributions of funds allowed under § 529(c)(3)(D). Unresolved ambiguity may lead to inconsistent approaches among different 529 Programs. Currently two interpretations exist: (i) re-contribution should be treated as a new contribution – entirely as principal; or (ii) re-contributed funds should be treated in similar fashion to a rollover, i.e., the principal/earnings breakdown of the applicable portion of the withdrawal that is re-contributed is applied, and absent documentation of such breakdown the entire re-contribution is deemed to constitute earnings.

The College Savings Network and others in the 529 industry believe that the intent of this legislation was to treat re-contributed funds as new contributions (entirely principal) for the following reasons:

1. Re-contributions are likely to occur in unplanned situations

Throughout the 529 industry’s advocacy of this legislation, the envisioned circumstances for refund and re-contribution were, and continue to be, unplanned situations where the owner of the account had little to no notice of the need for such a transaction. Instances of sudden hardship including illness or family crisis, or a late and unexpected award of a scholarship or grant, are the most likely scenarios where a refund of qualified higher education expenses followed by a re-contribution of a withdrawal would occur. The 529 industry sought this reform with the intent to provide a hardship exception to account owners following an unforeseen event, by allowing for a seamless tax-free re-contribution of the funds. Accordingly, we believe the intent of the legislation was to treat a re-contribution as a new contribution; there is certainly no statutory evidence that any other treatment was contemplated by Congress.

2.The likelihood of tax abuse is low

It is highly unlikely that an account owner could utilize this exemption to intentionally convert potentially taxable earnings to principal, so as to lower the taxable portion of potential future unqualified withdrawals. To qualify as a re-contribution, the amount must constitute a refund of qualified higher education expenses. There must be a designated beneficiary who actually incurred a qualified higher education expense, paid it to an eligible educational institution, and, following payment, ceased attending or received a scholarship or other credit that decreased the amount due and generated a refund. Among numerous other reasons that intentional misuse of this exception is unlikely, refunds for early withdrawal often entail a substantial penalty that would often dwarf the effect of any hypothetical future tax benefit. Similarly, the notion that an account owner would intentionally overpay for tuition in order to recontribute at a higher basis for purposes of a future nonqualified withdrawal involves a degree of convolution that is highly unlikely and extremely limited in potential applicability. Moreover, the basis/earnings allocation of the re-contribution is only relevant if this designated beneficiary, who has been attending an eligible educational institution, incurs no future qualified higher education expenses, as any future qualified higher education expenses would qualify for tax-free withdrawal irrespective of the earnings component.

3. Re-contribution is cumbersome to track unless treated as a new contribution

There is no existing systematic way to determine if a contribution is being made from a refund, as defined in the statute. Recordkeeping systems would need to be modified to create a new type of contribution. In addition there is no systematic way to calculate an accurate principal to earnings ratio. The account owner may have had multiple withdrawals or contributions prior to receiving a refund. There is no way for a 529 Program to determine whether a contribution is associated with a particular distribution in order to calculate the applicable principal and earnings ratio, even if the re-contribution is made to the same 529 Program as the related withdrawal(s). Additionally, because Section 529(c)(3)(D) provides that the refunded funds may be re-contributed into a different 529 Program plan as long as the beneficiary is the same, principal and earnings would be even more difficult to track.

If re-contributions are not treated as a new contribution, additional questions will be raised. For example, it would need to be determined whether the re-contribution must return to the previous investment option to avoid this transaction counting as one of the two annually permitted exchanges.

Not treating a re-contribution as a new contribution would likely lead to a negative experience for account owners as it adds confusion, procedure, and time to what may be an already difficult situation.

4. Statutory interpretation suggests treatment as a new contribution

The amendments contained within the PATH Act regarding re-contributions are set forth within 26 U.S.C. § 529(c)(3)(D), in the “Distributions” section, under subsection “Special rule for contribution of refunded amounts.” Because these types of transactions were given their own subsection rather than being included under the “Rollover” subsection, CSPN is of the view that Congress intended PATH Act re-contributions to be treated as new contributions and not as rollovers. We believe that if Congress intended earnings and principal to be tracked in connection with a re-contribution, as with rollovers, Congress would have revised the rollover portion of 26 U.S.C. § 529 to provide for such.

Conclusion

Based on the above analysis, CSPN is asking the Treasury Department for an interpretive notice that confirms CSPN’s position that funds recontributed pursuant to the PATH Act are treated as new contributions by the 529 Program receiving those contributions.

Thank you for your consideration of our request. I look forward to hearing from you at your earliest convenience. For any additional information please contact me at xxxx.

Sincerely,

Hon. Young Boozer
CSPN Chair & Alabama State Treasurer