October 04, 2023

Credit: Washington Post

Members of Maryland’s congressional delegation are asking the Internal Revenue Service to spare families invested in the state’s prepaid college savings plan from a hefty tax penalty they could face to access the money in their accounts.

The request comes months after Maryland’s state treasurer said his office would retroactively apply a 6 percent earnings rate to prepaid accounts that had been frozen for more than a year after what the 529 agency called a calculation error that incorrectly inflated balances.

During the suspension of earnings, 500 families rolled over the principal balance of their accounts into Maryland’s traditional 529 plan. But they must file a claim with the state to get the retroactive earnings, then roll that money over again.

By law, owners of 529 accounts are limited to one tax-free rollover per beneficiary within a 12-month period. Additional rollovers during that time would be subject to a 10 percent tax penalty. Lawmakers, citing the “unique and unexpected circumstances” related to the 529 accounts, are urging the IRS to let families execute additional rollovers from their prepaid accounts without penalty.

“This is a matter of basic fairness for thousands of our constituents,” said Rep. Jamie B. Raskin (D-Md.), who led the group of lawmakers in sending a letter Wednesday to the agency. “We hope the IRS can act.”

Raskin signed the letter alongside Reps. David Trone, C.A. Dutch Ruppersberger and John Sarbanes, and Sen. Chris Van Hollen — all Democratic lawmakers.

“The [prepaid college trust] account errors caused considerable financial and emotional hardship on many parents and students,” lawmakers wrote in the letter to the IRS. “We ask you to help alleviate this situation facing many of our constituents.”

Lisa Getter Peterson, an account holder who has helped organize parents, brought the tax issue to the attention of congressional lawmakers over the summer.

“Why should account holders be penalized for something they couldn’t control?” she said.

Getter Peterson noted that the tax penalty would also harm families with multiple prepaid plans if they want to roll over some or all of those accounts.

The Maryland Prepaid College 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, there are 3,697 prepaid trust beneficiaries who have more than one account, according to the Maryland state treasurer.

Michael Dubsky, who lives in Carroll County, Md., has three prepaid plans for his daughter and four for his son, totaling about $155,000. Come July, the accounts will no longer earn any interest as the state winds down the trust. Rolling over the plans, Dubsky said, makes the most sense, but could cost him $15,500 in taxes.

“It’s a lot of money to throw away,” Dubsky said. “I’ll be forced to make a decision before July, but I’m willing to wait to see if Congressman Raskin can get a waiver.”

The IRS has relaxed its rules before. Last summer, the agency waived penalties for nearly 1.6 million people who struggled to file their tax returns on time during the pandemic. The IRS automatically issued more than $1.2 billion in refunds or credits.

A spokesperson for Maryland State Treasurer Dereck E. Davis said his office has been proactively working with Raskin and supports the effort to deliver tax relief to account holders. On Wednesday, the treasurer’s office opened a portal to let prepaid account holders submit claims for the retroactive earnings and encouraged them to do so by Dec. 31.

Davis took the helm of the Maryland 529 agency on June 1, after Gov. Wes Moore (D) signed legislation to overhaul the agency that runs the state’s two college savings plans. Lawmakers and account holders criticized Maryland 529 for obfuscation and incompetence in its handling of the earnings debacle.

Dubsky and Getter Peterson praised Davis for bringing about a resolution that lives up to what families were promised.