January 24, 2008
STATE TAX DEDUCTION FOR CHET CONTRIBUTIONS
By: Judith Lohman, Chief Analyst
You asked (1) why the Connecticut income tax deduction for college savings plan contributions is limited only to contributions to the Connecticut Higher Education Trust (CHET), which is Connecticut's state-run college savings plan and (2) how other college savings funds might be able to take advantage of the Connecticut tax break.
The legislative history of the law creating the tax deduction for CHET contributions does not provide any explicit rationale for limiting the deduction just to CHET. Public hearing testimony on the original proposal from State Treasurer Denise Nappier implies that one reason was to enhance CHET's competitive position against other states' college savings plans. Of the 42 states with state income taxes, only seven do not provide a state income tax deduction for contributions to their state college savings plans. But 30 of the 35 states with deductions restrict their deductions to contributions to the state's own plans.
The only way other states' college savings plans could take advantage of Connecticut's state income tax deduction would be for the General Assembly to change the law. A bill to do so was introduced in the 2007 session (SB 125), but did not become law.
TAX DEDUCTION FOR CONTRIBUTIONS TO CHET
In 2006, the General Assembly allowed taxpayers to deduct contributions to CHET from their Connecticut adjusted gross income for state income tax purposes. The law limits annual deductions to $5,000 for individual taxpayers and $10,000 for joint filers. It allows taxpayers to carry forward any unused deductions for contributions on or after January 1, 2006 for the five following years as long as each deduction does not exceed the annual maximum. Rollovers from other state 529 plans into CHET do not qualify for the deduction (CGS § 12-701 (20) (B) (xii)). State college savings plans are known as “529 plans” after the Internal Revenue Code section that allows states to set up the tax-advantaged plans.
LEGISLATIVE HISTORY ON REASON FOR LIMITING THE DEDUCTION TO CHET CONTRIBUTIONS ONLY
A search of the legislative history of the CHET income tax deduction does not provide any definite explanation of why the legislature chose to limit the deduction only to CHET contributions.
The CHET deduction was enacted in the 2006 budget and tax package, which the House and Senate considered as an emergency certified bill (HB 5845, PA 06-186). Although legislators briefly mentioned the CHET deduction during the extensive debate on the bill in the House and Senate, no one raised the question or stated any reason why the bill did not extend the deduction to all types of college savings funds.
The Higher Education and Employment Advancement Committee had considered and held a public hearing on the deduction as a separate bill in 2006 (HB 5526). Three witnesses testified in favor of the bill: State Treasurer Denise Nappier, who oversees CHET; Valerie Lewis, commissioner of higher education; and Richard Croce, vice president and general counsel for the Connecticut Student Loan Foundation.
Nappier was the only one of the three to identify “competition” with other states' college savings programs as a reason to enact the tax deduction for CHET contributions. She argued that the fact that other states give tax deductions for contributions to their state plans “requires an enhanced strategy for CHET.” This testimony implies that one reason for the treasurer's support for a deduction limited to CHET was that it would enhance CHET's competitive position compared to other funds.
In the 2007 session, after the CHET deduction became law, the Higher Education Committee raised a bill (SB 125) to extend the deduction to any 529 college savings plan, not just CHET. The committee held a public hearing on the bill, at which there was no discussion of the reasons for making the change. One witness, Marc Herzog, chancellor of the community-technical college system, registered his support for the bill. In written testimony summarized in the committee's JF report, Treasurer Nappier also supported the change, “provided the bill contains safeguards against tax manipulation.”
The Higher Education Committee gave a joint favorable report to a substitute version of SB 125 and sent the bill to the Finance, Revenue and Bonding Committee (copy attached). The Finance Committee stripped the bill's contents and used it as a vehicle for a different bill. Thus, the original provisions of SB 125 were not reported to the floor and the issue was not debated in 2007.
HOW OTHER COLLEGE SAVINGS PLANS CAN TAKE ADVANTAGE OF THE CONNECTICUT TAX DEDUCTION
Under current law, the tax deduction is limited to CHET contributions. In order for other plans to be eligible for the deduction, the legislature would have to change the law. sSB 125 as reported by the Higher Education Committee in 2007 provides one model for expanding eligibility for the credit. It would have allowed Connecticut taxpayers to deduct contributions to college savings plans run by other states as well as Connecticut. Under federal law, only states can sponsor 529 plans, though, like CHET, most state plans are actually run by private financial services firms, such as Merrill Lynch.
Although all but a few states that have state income taxes provide a tax deduction for college savings plan contributions, most such laws follow Connecticut's model and limit the state tax benefit to contributions to their own 529 plans. Only five states provide tax benefits to taxpayers who contribute to out-of-state as well as in-state plans. These states are:
● Arizona. For tax years 2008 through 2012, Arizona allows an annual tax deduction for contributions to any state 529 plan. The maximum deduction is $750 for single and $1,500 for joint filers per beneficiary, per year.
● Arkansas. Interest dividend and capital gains from funds invested in any state's 529 plan are exempt from Arkansas income tax. But only contributions to Arkansas' 529 plan are tax deductible (up to $5,000 for single and $10,000 for joint filers per beneficiary, per year.)
● Maine. Maine allows a maximum deduction of $250 per beneficiary for contributions to any state's 529 plan. The deduction applies to taxpayers with federal adjusted gross incomes of $100,000 or less for singles and married couples filing separately and $200,000 or less for joint filers and heads of household.
● Kansas. Kansas allows taxpayers to deduct contributions to any state's 529 plan up to a maximum of $6,000 for joint filers and $3,000 for other filers.
● Pennsylvania. Pennsylvania allows a tax deduction for contributions to any state's 529 plan. The annual per-beneficiary limit is tied to the federal gift tax exclusion, currently $12,000 per beneficiary. In addition, 529 plan distributions used for higher education expenses and federally qualified rollovers from any state 529 plan are not subject to Pennsylvania income tax.