Loophole can mean big bucks

Future Scholar program has no waiting period

The Post and Courier

Want to knock 7 percent off this fall's college tuition bill?

Using a South Carolina program intended to encourage long-term investing for college expenses, state residents can get a substantial tax break by parking their money in the state program for just a few days.

"You could call this one of the last true tax loopholes," said DeAnna Moss, tax manager at the financial advisory firm Dixon Hughes, in Charleston.

State Treasurer Converse Chellis said the rules for South Carolina's Future Scholar 529 College Savings Plan might need to be changed if the program is abused, but he confirmed the tax maneuver is legal.

"We're not anxious to say that's one of the things you can do with it," Chellis said. "That's not what it was designed for."

Here's how it works:

Future Scholar contributions by South Carolina residents can be deducted from taxable state income, as long as the money is later spent upon qualified higher education expenses.

While the plan is meant for long-term savers, investments may be withdrawn immediately and without penalty.

State residents preparing to write a tuition check could essentially get a quick 7 percent return on their money by making an in-and-out contribution to a Future Scholar account, allowing them to claim the money as a state tax write-off.

Qualifying expenses include not only tuition, but room and board, books and fees, regardless of where the college or university is located.

For someone facing a $10,000 tuition

bill, the tax break could mean a savings of $700. Over the course of four years of college, the tax break could be worth thousands of dollars.

The state's tax rate is 7 percent on income over $11,100.

"You would be surprised how many clients I've gotten as new clients because I told them about it," Moss said.

She said the tax benefit particularly appeals to high-wealth clients because 529 plans such as Future Scholar do not have income restrictions found in programs like the federal Hope Scholarship tax credit.

Ed Miller, director of financial aid at University of South Carolina, said using a last-minute contribution to Future Scholar to gain a state tax advantage would be impossible for most families because they don't have the money.

"The population we are working with are primarily people who are looking for money, not those who might have that kind of money set aside," he said. "It's not something that would be viewed as a financial aid resource, in the traditional sense."

The federal government created the framework for 529 plans in the 1990s.

States individually operate the plans, and savings plans such as Future Scholar are similar to a Roth IRA.

Participants may invest money in a range of funds, and there is no tax on investment earnings as long as the money is used for the intended purpose.

"The 529 plan was designed so that people could put money aside, and maybe 10 years later that money grew through investing, and they could withdraw the money without taxes on the appreciation," Chellis said.

However, a South Carolina contributor could realize a substantial short-term return from the tax deduction alone.

"That's a known loophole in a lot of these plans," said Mark Kantrowitz, publisher of finaid.org, a Web site recommended by Future Scholar.

"You can put money in, and as long as you are taking a distribution to pay qualified higher education expenses, there are no state or federal tax implications, and you benefit from the state tax deduction," he said.

If Future Scholar money is not spent on qualified expenses, any state tax savings would have to be repaid. State and federal taxes also would be due on any earnings, plus a 10 percent federal penalty on earnings.

Future Scholar opened in 2002 under legislation authored by state Sen. Chip Campsen, R-Isle of Palms.

Campsen said he's aware of the tax loophole.

"I've had people ask me about this, and I've told them this can be done," he said. "I don't mind giving folks tax incentives to help with educational expenses."

Campsen said that requiring a waiting period might have been unfair to people who had college-bound children at the time the program was created.

"The real power of this (Future Scholar program) is the power of tax-free, compound returns," Campsen said. "Folks who are doing this, by and large, are people investing early."

After a Future Scholar account is opened and money is contributed, funds can be withdrawn by phone, fax or online. The money can be sent back to the contributor or to a school.

"It would probably take about a week to get a check," said Jenny W. McGill of the state Treasurer's office, program director for Future Scholar.

For South Carolina residents investing in Future Scholar's "direct plan," there is no fee to open or maintain an account, or withdraw funds. The plan also offers "advisor" accounts set up by brokers, and those accounts carry substantial fees.

Future Scholar participants can invest in funds ranging from a money market account to stock and bond funds. Each has a small management fee that amounts to less than one percent of the balance yearly.

Campsen and Chellis said that if it seems the tax break is being abused, the state may consider changing the rules.

"It's a matter of how it's utilized and how much it's costing the state," Campsen said.

The state has no estimate of how much tax revenue has been foregone because of Future Scholar contributions.

Reach David Slade at 937-5552 or dslade@postandcourier.com.