To encourage saving for college, the government created qualified tuition plans, commonly called 529 plans, complete with tax-sheltered growth and tax-free qualified distributions. Qualified distributions include the costs of college, trade school and graduate school expenses. However, 529 plans only accept cash contributions, so you have to sell your stocks to get the money to contribute.
There's no exception in the tax code that allows you to shelter profits from your stock sales if you put the money in a 529 plan. To figure your taxable profits from the sale, you must subtract your basis from your net proceeds. Your basis is what you paid for the stocks, including any commissions, and your net proceeds are what you received from the stock sale, minus any commissions. For example, say you paid $6,000 for stock and a $19 commission and then sold it for $8,019 and paid another $19 commission. Your taxable stock profits equal $1,981.
Tax Rates on Stocks
Not all stock profits are taxed equally. If you owned the stock for one year or less, the profits are taxed just like your ordinary income -- at rates as high as 39.6 percent as of 2013. But, if you owned the stock for more than one year, your profits count as long-term capital gains. These are taxed at lower rates, with the maximum rate being just 20 percent as of 2013.
Contribution Limits and Deductions
Once you've got the cash in hand, the IRS doesn't put a specific dollar limit on how much you're allowed to contribute to the 529 plan each year. Instead, the IRS just restricts your contributions to "the amount necessary to provide for the qualified education expenses of the beneficiary." There's no federal income tax deduction for 529 plan contributions, but depending on which state you live in, you might qualify for a state income tax break for your contributions.
Gift Tax Implications
If you're making contributions to a 529 plan for someone else, you might be making a taxable gift if you're depositing a large enough amount. As of 2013, you're allowed to contribute up to $14,000 each year per beneficiary. In addition, there's a special option for 529 plans that lets you treat your contribution as if you made it in equal installments over a five-year period. That means that you could put up to $70,000 in a 529 plan and, using the five-year averaging option, pay no gift taxes.
- IRS: Publcation 550 -- Investment Income and Expenses
- CNN Money: What's the Best Way to Transfer Stocks to My Granddaughter for Her College Fund?
- IRS: Topic 409 -- Capital Gains and Losses
- IRS: Publication 970 -- Tax Benefits for Education
- FinAid: State Tax Deductions for 529 Contributions
- US News: 3 Changes to 529 Savings Plans This Year
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