The Department denied my 2017 deduction for carryover contributions to my kids' Virginia 529 prepaid tuition accounts, saying I'd already used up all my carryovers in earlier years -- but I think my math is right. Can the Department go back and recheck years that are now outside the statute of limitations?

Plain-English summary

Virginia lets taxpayers deduct contributions to Virginia 529 prepaid tuition contracts and savings trust accounts, generally capped at $4,000 per contract or account per year (raised from $2,000 before the 2009 taxable year), with any excess carried forward to future years -- or, for contributors age 70 or older, the entire remaining balance can be deducted at once (Va. Code § 58.1-322.03 7 a-b). This ruling is a genuine taxpayer win that turns on a fairness principle: the Department has to play by the same year-by-year rules it holds taxpayers to.

A couple owned five Virginia prepaid tuition contracts (three under the husband's name, two under the wife's) and claimed a deduction on their 2017 return for carryover contributions. The Department's audit found that, over the years from 2005 through 2016, the couple had sometimes deducted MORE than the maximum allowed for a given year -- meaning that by 2017, they had cumulatively deducted more than they'd actually contributed, with nothing left to carry forward. On that basis, the Department initially denied the entire 2017 deduction and the couple paid the resulting assessment before appealing.

Here's the turn: the Department's own established rule (P.D. 10-240) is that a 529 deduction must be claimed in FULL in the year it's available -- taxpayers can't skip a year and bank an unclaimed deduction for later; the only way to fix an under-claimed deduction from an earlier year is to file an amended return within the three-year statute of limitations (Va. Code § 58.1-1823). The Department realized that same principle has to cut against ITSELF too: since the couple's over-claimed prior years (2005 through some point before 2017) were now outside that same three-year window, the Department could no longer go back and correct those years directly. Instead, the Department was limited to recalculating what the couple's 2017 deduction WOULD have been if they had claimed the legally correct (not the larger, actually-claimed) amount in every earlier year.

The audit staff built a corrected year-by-year schedule reconstructing the couple's proper deduction history -- and the resulting allowable 2017 amount turned out to match exactly what the couple had actually claimed on their 2017 return. So the original assessment was abated and a refund issued. Going forward, the couple was advised to apply that same corrected schedule to their post-2017 returns and file amended returns if those later years' claimed deductions don't match the corrected numbers.

What this means for you

Anyone contributing to multiple Virginia 529 prepaid tuition contracts or savings trust accounts

Track your annual cap ($4,000 per contract/account, unless you're 70+) and any carryforward balance carefully, year by year, across every contract. Deducting more than the maximum in one year can throw off your carryforward math for years afterward -- and once a year falls outside the three-year amended-return window, an error there generally can't be fixed directly, for either you or the Department.

Anyone whose 529 deduction claim spans many years with some now outside the statute of limitations

If you (or the Department) find an error in a long-closed year, the fix isn't to reopen that year -- it's to recalculate your CURRENT year's allowable deduction as if the correct amount had been claimed in every earlier year, and apply that reconstructed number going forward.

Anyone who paid an assessment and is unsure whether to appeal

This case shows an appeal can genuinely succeed even after paying the assessment -- the couple paid first, then appealed, and ultimately got a full abatement and refund once the Department worked through the year-by-year math correctly.

Common questions

Q: I claimed more than the annual maximum 529 deduction in some past years -- does that mean I've used up my whole carryforward?
A: Not necessarily in the way an initial audit might assume. If those over-claimed years are now outside the three-year statute of limitations, the Department has to recalculate what your CURRENT deduction would be as if you'd claimed the correct (capped) amount each year -- not simply treat your actual over-claimed history as final.

Q: Can the Department go back and fix my 529 deduction errors from more than three years ago?
A: Generally no -- the same three-year limitations period that stops a taxpayer from amending an old return to claim a missed deduction also limits the Department's ability to directly correct an old year's over-claimed deduction.

Q: What should I do if I think my 529 deduction carryforward math might be off across several years?
A: Build (or ask a tax professional to build) a corrected year-by-year schedule showing the maximum allowable deduction for each year, and compare it to what you actually claimed -- then apply any needed corrections to your open (non-time-barred) years going forward.

Citations and references

• Va. Code § 58.1-322.03 7 a (deduction for contributions to a Virginia 529 prepaid tuition contract or savings trust account, capped at $4,000 per contract/account per year with carryforward for excess amounts; $2,000 cap before the 2009 taxable year)
• Va. Code § 58.1-322.03 7 b (contributors age 70 or older may deduct the full remaining amount paid, less prior deductions)
• P.D. 10-240 (10/1/2010) (a 529 deduction must be fully claimed in the year available; missed deductions can only be corrected via a timely amended return)
• Va. Code § 58.1-1823 (three-year statute of limitations for filing an amended Virginia income tax return)

Subject

Deduction : Prepaid Tuition - Contribution Limitations and Carryovers

Source

• Landing page: Virginia Laws, Rules & Decisions
• Ruling: P.D. 22-54

Original ruling text

March 30, 2022

Re: § 58.1-1821 Application: Individual Income Tax

Dear *:

This will reply to your letter in which you seek correction of the assessment of individual income tax issued to * (the “Taxpayers”) for the taxable year ended December 31, 2017.

FACTS

The Taxpayers, a husband and wife, filed their 2017 Virginia income tax return claiming a deduction for the carryover of contributions made to five Virginia 529 college savings accounts. Under review, the Department increased the amount of federal adjusted gross income (FAGI) the Taxpayers reported on their Virginia return to match the FAGI reported on their federal return. The Department also denied the deduction for the carryover of contributions made to the 529 accounts on the basis that the Taxpayers had utilized all of their contribution carryovers prior to the 2017 taxable year. The Taxpayers paid the resulting assessment and filed an appeal, contending that the documentation provided shows that there were enough contribution carryovers to claim the deduction.

DETERMINATION

Virginia Code § 58.1-322.03 7 a allows a deduction to the purchaser or contributor for the amount paid or contributed during the taxable year for a prepaid tuition contract or savings trust account entered into with the Virginia College Savings Plan. Generally, the amount deducted on any individual income tax return in any taxable year is limited to $4,000 per prepaid tuition contract or savings trust account. To the extent the purchase price or the amount paid during the year exceeds $4,000 per contract or account, the remainder may be carried forward and deducted in future taxable years. The deduction was limited to $2,000 per prepaid tuition contract or savings trust account prior to the 2009 taxable year.

Pursuant to Virginia Code § 58.1-322.03 7 b, a purchaser of a prepaid tuition contract or savings trust account who has attained age 70 is allowed to deduct the full amount paid for the contract or account, less any amounts previously deducted.

The Taxpayers purchased five Virginia prepaid tuition contracts with the husband named as the owner of three contracts and the wife as the owner of two. The Taxpayers’ documentation shows that contributions were made to two contracts for each year from 2005 through 2013. It shows that one contribution was made to a third prepaid contract in 2010. The documentation further shows that contributions were made in 2016 to two other contracts. Some of the deductions the Taxpayers took in previous taxable years exceeded the maximum allowable for that year. By the time the Taxpayers filed the 2017 return at issue, they had cumulatively taken deductions that exceeded their total contributions. The audit staff denied the deduction the Taxpayers took on their 2017 return on this basis.

In Public Document (P.D.) 10-240 (10/1/2010), the Department ruled that taxpayers may only claim a prepaid contract deduction for a contribution made for a particular taxable year in that year and any carryover must be claimed in successive years. In other words, taxpayers must fully claim the deduction in the years in which they are eligible to claim the deduction. The only way for a taxpayer to claim a deduction they did not take but could have for a previous year is to file an amended Virginia income tax return within the three year limitations period provided by Virginia Code § 58.1-1823.

Just as taxpayers must claim the maximum allowable deduction for a respective taxable year and are prohibited by the Department’s policy set forth in P.D. 10-240 from carrying over amounts they could have taken as a deduction in prior years but did not, the Department must be held to a similar standard as to the timing of its adjustments. In this case, the Department had the opportunity to correct the Taxpayer’s overstated deductions in prior taxable years that are now beyond the statute of limitations. For the period at issue, the Department is limited to adjusting the deduction to the maximum allowed had the Taxpayers correctly claimed deductions in prior taxable years.

To assist with analyzing this appeal, the audit staff supplied a schedule showing what the Taxpayers’ allowable deduction for the 2017 taxable year would be if the Taxpayers had previously claimed the proper deduction amounts. This amount corresponds to the amount claimed by the Taxpayers on their 2017 return. Accordingly, the assessment will be abated and a refund issued as warranted.

Based on information provided, the Taxpayers’ deductions for subsequent taxable years are limited to the amounts computed on this schedule, copy attached. As such, the Taxpayers are advised to review the deductions claimed in subsequent years and file amended returns, if necessary, to correct their college savings account deductions.

The Code of Virginia sections and public document cited are available on-line at www.tax.virginia.gov in the Laws, Rules & Decisions section of the Department’s web site. If you have any questions regarding this determination, you may contact * in the Office of Tax Policy, Appeals and Rulings, at ***.

Sincerely,

Craig M. Burns

Tax Commissioner

AR/3786.B

Related Documents

10-240