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New Jersey Deductions for Higher Education Expenses and Savings

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New Jersey Deductions for Higher Education Expenses and Savings

Beginning in 2022, the New Jersey College Affordability Act allows New Jersey taxpayers tax deductions for certain educational expenses. The deductions are targeted for taxpayers with gross income of $200,000 or less. Deductions are allowed for contributions to the NJBEST college savings plan, in-state higher education tuition costs and NJCLASS loan repayments.

529 College Savings Plan – NJ BEST

A 529 plan is a tax-advantaged savings plan authorized by Section 529 of the Internal Revenue Code and designed to encourage saving for future education costs.  All fifty states and the District of Columbia sponsor at least one type of 529 plan.

In 2021, investment research firm, Morningstar, upgraded its analyst rating of the New Jersey Better Educational Savings Trust, or NJBEST, from negative to neutral.  Previously, Morningstar had ranked NJBEST among the worst 529 college savings plans in the nation because of high fees, limited options and few incentives to entice residents to sign up compared to plans in other states.

The new law offers incentives to invest in the NJBEST college savings plan.  Beginning in 2022, a taxpayer with gross income of $200,000 or less can deduct from New Jersey gross income the taxpayer’s NJBEST contribution for the taxable year up to $10,000. New Jersey becomes the 35th state to offer an income tax benefit for residents who contribute to a 529 plan. The new deduction is estimated to cost the state between $9.5 million and $12.1 million in lost revenue annually.

The state income tax deduction is allowed to any taxpayer who contributes to a NJBEST 529 plan. Parents, grandparents, other family members and friends can make the tax-deductible contributions for the benefit of an account beneficiary.

Under a 529 plan, the plan investment grows tax-free while it remains in the plan. If plan distributions are used for qualified educational expenses, the earnings remain tax-free. New Jersey follows federal tax rules regarding withdrawals from a 529 savings plan qualified higher education expenses. Expenses that can be paid using funds from a 529 account for a beneficiary include:

  • Tuition, mandatory fees, books, supplies and equipment required for the beneficiary to enroll and attend an eligible educational institution.
  • A computer, peripheral computer equipment, software and internet access used while enrolled in an eligible educational institution.
  • Room and board if the beneficiary is enrolled at least half time. Half-time enrollment is defined as half of a full-time academic semester or term workload. Costs cannot exceed the allowance for room and board as determined by the eligible educational institution.
  • Expenses for services for a special needs beneficiary to enroll and attend an eligible educational institution.
  • $10,000 per year in K-12 tuition at public, private or religious schools.
  • Fees, books, supplies and equipment required for the participation in a registered apprenticeship program registered with federal Department of Labor.
  • Qualified education loan repayments – lifetime limits to $10,000 in qualified student loan repayments per 529 plan beneficiary and $10,000 per each of the beneficiary’s siblings.

Withdrawals made for nonqualified expenses may trigger federal and state taxes on earnings and penalties.

A rollover from one account to another is considered a qualified distribution within the meaning of N.J.S.A. 54A:6-25 as long as it meets the requirement in section 529(c)(3)(C)(i) of the Internal Revenue Code.

The annual state tax benefit of contributing $10,000 to a NJBEST college savings plan ranges from $140 to $637 ($10,000 times 6.37%, the top tax rate for taxpayers which income of up to $200,000). The lower a taxpayer’s income tax bracket, the smaller the New Jersey tax savings.

The New Jersey income tax benefits should not be the only consideration when deciding whether to contribute to the NJBEST college savings plan.  Fees and fund performance remain important factors. Better investment performance of another state’s 529 plan could, over time , outweigh the benefit of the new state income tax deduction.

A second new incentive is reserved for taxpayers with New Jersey income of $75,000 or less. The state will make a dollar-for dollar matching grant, up to $750, of the initial deposit to the account when opening a NJBEST account on or after June 29, 2021. The matching grant is limited to no more than one account per beneficiary. The New Jersey Higher Education Student Assistance Authority will verify income, including a review of IRS tax transcripts. The matching grant funds cannot be withdrawn until the new account has remained open for at least three years. The grant is funded with an appropriation of $10 million.

Students who have NJBEST account and go to college in New Jersey can receive a tax-free scholarship. Effective June 7, 2021, the maximum NJBEST scholarship amount was increased to a total of $3,000. The longer contribution at or above minimum contribution levels are made, the greater the college scholarship amount. After qualifying for a $1,000 scholarship, further contributions increase the scholarship by $500 every 2 years, up to a maximum of $3,000. The scholarship is only available for college and is awarded any fall or spring semester of college. The NJBEST Scholarship is provided by the New Jersey Higher Education Student Assistance Authority.

Deduction for In-State Higher Education Tuition Costs

Beginning in 2022, a taxpayer with gross income of $200,000 or less can deduct up to $10,000 from the taxpayer’s gross income for tuition costs paid to an in-State institution of higher education during the taxable year. The deduction is allowed for tuition costs related to the enrollment of the taxpayer or a spouse or dependent of the taxpayer at the institution. No deduction is allowed for tuition costs paid to an out-of-state institution of higher education.

An “institution of higher education” means a postsecondary educational institution that provides instruction beyond the 12th grade level in programs that satisfy the requirements for a degree at the associate, baccalaureate, or graduate level, and which, with the exception of institutions that have a specialty mission, offers a range of degree programs. “Tuition costs” means the charges imposed by an in-State institution of higher education that are designated by the institution as the tuition costs required for the enrollment or attendance at the institution.

The annual state tax benefit of paying in-state tuition of $10,000 ranges from $140 to $637 ($10,000 times 6.37%, the top tax rate for taxpayers which income of up to $200,000). The lower a taxpayer’s income tax bracket, the smaller the New Jersey tax savings. The new in-state tuition deduction is estimated to cost the state between $71 million and $82.4 million in lost revenue annually.

New Jersey College Loans to Assist State Students Loan Program

Beginning in 2022, a taxpayer with gross income of $200,000 or less can deduct from gross income up to $2,500 of principal and interest payments paid on a student loan under the NJCLASS Loan Program. NJCLASS loans are available to New Jersey residents attending an approved undergraduate or graduate school, whether in-state, out-of-state, on-line or abroad.

NJCLASS offers 10 and 15-year ReFi+ refinance loan programs available to NJCLASS, federal Parent PLUS and private educational loan borrowers with a minimum of $5,000 in debt. Refinancing through the NJCLASS program may offer more favorable loan rates and qualify for the new gross income tax deduction.

The annual state tax benefit of the $2,500 deduction for NJCLASS loan repayments ranges from $35 to $159 ($2,500 times 6.37%, the top tax rate for taxpayers which income of up to $200,000). The lower a taxpayer’s income tax bracket, the smaller the New Jersey tax savings. The new in-state tuition deduction is estimated to cost the state between $6.5 million and $11.8 million in lost revenue annually.

Taxation of Excess Distributions

The new law clarifies the New Jersey taxation of distributed earnings from a Coverdell education savings account, a qualified tuition program account, or a qualified ABLE account which are not otherwise excluded from income. The taxable portion is the amount of the excess distribution that represents earnings that have accumulated tax free in the account. Upon distribution, the nonexcludable amount of the distribution is taxable pro rata, based on the amount of contributions and earnings in the Coverdell education savings account, a qualified tuition program account, or a qualified ABLE account.

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