The Internal Revenue Service on Thursday agreed to help families invested in the Maryland prepaid college savings plan avoid a hefty tax penalty for rolling over money from their accounts.
The decision comes three months after members of Maryland’s congressional delegation implored the federal agency to have mercy on families who have been fighting for access to the entire amount of their savings. Maryland 529, the agency charged with running the state’s two college savings plans, suspended earnings on 31,000 prepaid tuition accounts in 2022, saying a calculation error incorrectly inflated balances.
“The IRS’s announcement is good news for Maryland,” said Rep. Jamie Raskin (D), who led the group of lawmakers in the request. “It will provide special tax relief to … many parents and students who were caught up in the earlier system errors and facing significant tax consequences through no fault of their own.”
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Parents have waged a relentless battle to force Maryland to make good on a promise to apply a 6 percent earnings rate to accounts in the Maryland Prepaid College Trust. They accused Maryland 529 of a breach of contract. After Maryland Treasurer Dereck E. Davis (D) took over the troubled agency last summer, he agreed to retroactively apply the earnings rate to the frozen accounts.
But that wasn’t the end of the turmoil. Families who had rolled over, or planned to roll over, their money to the state’s traditional 529 plan were at risk of hefty tax bills. The IRS limits owners of 529 accounts to one tax-free rollover per beneficiary within 12 months and imposes a 10 percent penalty on additional rollovers.
Last year, about 500 families with prepaid accounts had rolled over the principal balance of their accounts into Maryland’s traditional 529 plan to continue to grow their savings. To get the retroactive earnings, they had to file a claim with the state and then roll over that money again — which would have triggered the penalty.
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The tax also would have fallen on account holders with multiple prepaid plans if they chose to roll over some or all of those accounts. The prepaid trust, unlike the state’s traditional 529 plan, lets families lock in future tuition payments by purchasing semester credits by either the semester, the year or multiple years. As a result, 3,697 prepaid trust beneficiaries have more than one account.
To avoid financial hardship, the IRS will not penalize prepaid account holders who employ more than one rollover between Dec. 31, 2021, and Jan. 1, 2025.
The ruling is a relief to Michael Dubsky of Carroll County. The father of two has three prepaid plans for his daughter and four for his son, totaling about $155,000. Without the IRS ruling, Dubsky could have been on the hook for $15,500 in taxes from rolling over the plans.
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“This is a big win, and I give thanks to Congressman Raskin and his staff for helping,” he said. “People have been caught up in this mess for too long.”
Rollovers are especially attractive as the treasurer prepares to wind down the trust and reset the earnings rate to zero this summer. All account holders will have to transfer their money to the 529 investment plan to continue earning money on their accounts at that point. Now they will be able to do so without worrying about the tax burden.
“We were pleased to hear the news today from the IRS,” Davis said in a statement. “Our office was proud to proactively work with Congressman Raskin’s office and supported the effort to deliver this tax relief to account holders.”
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