Attorney Suggests Changes to Guidance on Tuition Plans

[2] We strongly support the Notice's guidance that a section 529 program will no longer be required to verify how distributions are used or to collect any penalty.

[3] This determination reflects the significant amendments made by the Economic Growth and Tax Relief Reconciliation Act of 2001 (Pub. L. No. 107-16) ("EGTRRA"). Among other things, EGTRRA repealed the requirement that section 529 plans must impose a more than de minimis penalty on any distribution of earnings not used for qualified higher education expenses. For 2002 and later years, if a distribution is not used for qualified higher education expenses, the tax imposed on the earnings portion must be increased by 10 percent of the amount includible in gross income. Section 529(c)(6). Compliance with this requirement is now entirely the responsibility of the taxpayer, not the section 529 program or State government.

[4] As indicated in out letter commenting on draft Form 1099-Q (dated February 15, 2002), we believe these amendments embody a policy that should focus the responsibility for complying with the various requirements of section 529 on the account owner. The account owner controls the distribution decision and is most likely to be in the best position after EGTRRA to collect, maintain and report information pertaining to the income tax consequences of a distribution from a section 529 plan. Accordingly, our prior comments recommend that final regulations require section 529 programs to provide the Form 1099-Q to the account owner in all cases.

[5] Consistent with this policy, we recommend that the Service, in final regulations, discard any requirement that a section 529 program and its State government serve a "recordkeeping and reporting agent" role with respect to specific information on basis or earnings. Instead, the Service should develop regulations and tax reporting regimes that clearly impose and focus the responsibility for maintaining and reporting basis and earnings on the account owner.

[6] After EGTRRA, the ultimate tax consequences arising from a distribution from a qualified tuition plan must be based upon tax records maintained by the taxpayer, not the section 529 program. The taxpayer must be responsible for knowing and applying (among other requirements) the rules coordinating tax consequences of use of various education incentives such as the Hope Scholarship Credit: and the Lifetime Learning Credit (section 25A), the Coverdell Education Savings Account (section 530) and the Qualified Tuition Plan (section 529). The taxpayer must be relied on to maintain correct and timely information regarding rollover transactions. The taxpayer must maintain appropriate documentation regarding the ultimate use of distributions.

[7] Ultimately, the Service's decision whether to require section 529 plans and State governments to serve as reporting and recordkeeping agents with respect to basis or earnings must balance the possible benefits of such an obligation against the potential costs. The costs of requiring section 529 plans to administer such a role are substantial.

[8] First, the administrative burdens associated with enforcing accurate and timely reporting by account owners to section 529 plans of basis information are overwhelming. Other commenters (such as the Investment Company Institute and College Savings Bank) are submitting comments that detail these very material burdens. We support and join in their comments and concerns. We note, however, that many of the suggestions designed to make the basis/earnings recordkeeping requirement somewhat palatable from an administrative viewpoint are difficult and require a complex and expensive coordination among Coverdell accounts, section 529 plans and other education tax programs.

[9] Second, the costs of this administrative burden ultimately must be borne by the account owners through higher fees, which will impact the very appropriate desire of States to offer low-cost vehicles for saving for higher education. Given that EGTRRA exempted from tax any distribution used for qualified higher education expenses, one must question whether imposing disproportionate costs and fees on programs and savers to address only the assumed case when account owners direct a distribution for non-qualified purposes is consistent with the general Congressional intent.

[10] We respectfully submit that the better answer, both from a policy and administrative point of view, is to develop regulations and tax reporting regimes that clearly impose and focus the responsibility for maintaining and reporting basis and earnings on the account owner. The most likely "constant" in all the diverse fact patterns governing tax treatment of section 529 distributions, and the person most likely to be able to collect, maintain and report compliance with the coordination provisions of these diverse tax requirements, will be the parent or account owner, not the section 529 plan, State government or the designated beneficiary. We recommend that the Service revise its approach to the role of section 529 plans from a "recordkeeping and reporting agent" to an "information and notification provider." The Service should develop regulations that require section 529 plans to form and notify account owners of their responsibilities regarding the tax consequences of investments in and distributions from section 529 plans. These requirements must be coordinated with an effective tax reporting regime that makes account owners responsible for maintaining adequate documentation and records regarding to justify claimed tax benefits.

[11] Owners of section 529 accounts are in a better position than section 529 programs to maintain and report information regarding basis and earnings in an account. Allocating this responsibility to the section 529 program would substantially increase overall transaction costs without materially improving the accuracy of records and ultimate compliance with the post-EGTRRA rules,

[12] We encourage the drafters of Notice 2001-81 to contact us with any questions about our comments.