Probate & Trust Law Section Conference Manual ... - Minnesota CLE

It is impossible for an account owner of an account for a given beneficiary to
know whether other accounts with different account owners exist for such
beneficiary, much less whether any such accounts have been rolled over during
the past twelve months. Therefore, the final regulations should make clear that
section 529(c)(3)(C)(iii) applies only if the particular account owner rolled over
the same or another account for the beneficiary within the last twelve months.
Accounts for the same beneficiary that have different account owners should not
be aggregated for this purpose.
B. Rollover with Beneficiary Change. A rollover to another state plan can still be
made at any time without adverse tax consequences if (a) the beneficiary is
changed, (b) the new beneficiary is a member of the family of the old beneficiary
and (c) the new beneficiary is not in a younger generation than the old
beneficiary. Code § 529(c)(3)(C)(i)(II).
C. State Income Taxation
1. Outgoing Rollover: Income Tax Deduction Recapture. In some states,
if a state income tax deduction was received for a contribution to a section
529 savings account and the account is then rolled over to a different state,
the income tax deduction would be recaptured. In some states recapture
applies only if the rollover occurs within a specific period of time after
opening the account. How the recapture is calculated if not all
contributions to the account qualified for the deduction may vary from
state to state.
2. Outgoing Rollover: Nonqualified Withdrawal Treatment. In some
states, outgoing rollovers will be treated as nonqualified withdrawals for
state income tax purposes.
3. Incoming Rollovers: Income Tax Deduction. In some states, rollover
contributions (or at least the principal portion of the rollover), as well as
original contributions, to the state program might qualify for the state
income tax deduction. In other states rollover contributions do not qualify
for the state income tax deduction or are only deductible if not previously
deducted.
D. Withdrawal and Recontribution Not a Rollover. A recent United States Tax
Court case illustrates how easy it is to violate unintentionally the distribution and
rollover rules under Code section 529 with disastrous results. In Karlen v.
Comm’r (T.C. Summary Opinion 2011-129, November 10, 2011), Tim Karlen
had 529 accounts for his three children. Tim began to experience some financial
difficulty when his income decreased because of the downturn in the national
economy and requested distributions of $3,500 from each of the 529 accounts.
On the request form, Tim indicated that the withdrawals were “nonqualified
withdrawals” rather than “withdrawals for rollover.” The 529 plan mailed the
three checks to him. After receiving the checks, Tim conferred with his wife
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