Can You Deduct 529 Contributions in Tennessee?

Saving for education can be expensive, and 529 plans offer a tax-advantaged way to set aside money for future costs. These state-sponsored accounts allow funds to grow tax-free when used for qualified expenses like tuition, fees, and books. However, tax benefits vary by state, making it important to understand how Tennessee treats these contributions.

Tennessee residents may wonder whether they can deduct their 529 plan contributions on state taxes. Understanding the tax implications can help maximize savings and avoid unexpected liabilities.

Who Can Open a Plan

Tennessee’s 529 plan, the TNStars College Savings 529 Program, is available to U.S. citizens and legal residents over 18 with a valid Social Security or taxpayer identification number. There are no residency restrictions, so non-Tennessee residents can also participate. However, Tennessee residents may benefit from using their home state’s plan due to lower fees or other advantages.

Parents and legal guardians typically open accounts for children, but grandparents, other relatives, and even family friends can contribute. Individuals can also open accounts for themselves if they plan to pursue further education. If the original beneficiary does not use the funds, they can be transferred to another eligible family member.

Contribution Amounts

The TNStars College Savings 529 Program allows contributions up to a total account balance of $500,000 per beneficiary. Once this limit is reached, additional deposits are not permitted, though the account can continue to grow through investment earnings.

Annual contributions are subject to federal gift tax rules. In 2024, individuals can contribute up to $18,000 per beneficiary without filing a gift tax return. Married couples who split gifts can contribute up to $36,000 per beneficiary annually. The IRS also permits a five-year lump sum contribution of up to $90,000 ($180,000 for married couples) without incurring gift tax, provided no further contributions are made during that period.

Tax Considerations for Residents

Tennessee does not have a state income tax on wages and salaries, so residents cannot deduct 529 plan contributions. Unlike states that offer tax deductions or credits, Tennessee’s tax structure does not include such incentives.

Despite this, Tennessee residents still benefit from tax-free growth and withdrawals when funds are used for qualified education expenses. Earnings in the account are not subject to capital gains taxes when withdrawn for eligible costs. Additionally, Tennessee does not impose a state-level estate or inheritance tax, which may be beneficial for those making large contributions as part of an estate planning strategy.

For those considering gifting strategies, 529 plan contributions qualify for the annual federal gift tax exclusion, reducing potential estate tax liability. Since Tennessee does not have a state gift tax, residents only need to consider federal limits when making large contributions.

Qualified Withdrawals

Withdrawals must be used for approved educational expenses to remain tax-free at the federal level. Qualified expenses include tuition, mandatory fees, books, supplies, and equipment required for enrollment at eligible institutions, including most accredited colleges, universities, vocational schools, and certain apprenticeship programs registered with the U.S. Department of Labor. Room and board costs qualify if the student is enrolled at least half-time, though limits apply based on the institution’s published cost of attendance.

Up to $10,000 per year per student can be used for K-12 tuition at private, public, and religious schools. Additionally, a lifetime limit of $10,000 can be applied toward student loan repayment for the beneficiary or their sibling.

Nonqualified Withdrawals

Using 529 funds for nonqualified expenses results in taxes and penalties. The earnings portion of the withdrawal is subject to federal income tax and a 10% penalty. Contributions are not taxed since they were made with after-tax dollars.

There are exceptions to the 10% penalty. If the beneficiary receives a tax-free scholarship, attends a U.S. military academy, becomes disabled, or passes away, withdrawals up to the scholarship or exempt amount can be made without penalty. However, income tax on earnings still applies. Planning withdrawals carefully can help avoid unnecessary taxes and penalties.