Could a taxpayer amend old Bright Start contribution years instead of adding a nonqualified 2011 withdrawal back at the higher 2011 rate?

Plain-English summary

The taxpayer had to report the addback in 2011 and could not rewrite correct contribution-year returns. The taxpayer properly contributed to Illinois Bright Start accounts and claimed the allowed subtraction in the earlier years.

When the taxpayer later made a nonqualified withdrawal, Section 203(a)(2)(D-22) required the previously deducted contribution component to be added to income in the distribution year. The earlier returns remained correct as filed, so there was no basis to amend them merely to avoid the later rate.

IDOR acknowledged that the 2011 5% rate exceeded the 3% rate that applied when the deductions were claimed, but said the Act provided no remedy.

What this means for you

Before a nonqualified 529 withdrawal, calculate the distribution-year addback using records of the Illinois deductions actually claimed. Do not assume recapture is limited to the original tax savings.

Common questions

Q: Could the taxpayer remove the old deductions by amendment?
A: No.

Q: Did Illinois apply the old 3% rate to the addback?
A: No.

Citations and references

• 35 ILCS 5/203(a)(2)(Y), (D-22)

Subject

Addition Modifications – Other Rulings

Source

• Landing page: https://taxarchive.illinois.gov/research/legal/letter-rulings/income-tax/2012.html
• Original PDF: https://tax.illinois.gov/content/dam/soi/en/web/taxarchive/research/legal/letter-rulings/income-tax/2012/it-12-0004.pdf

Original ruling text

IT 12-0004-GIL 03/13/2012 ADDITION MODIFICATIONS – OTHER RULINGS
General Information Letter: Taxpayer who claimed subtractions for contributions to
Section 529 plans is required to add back distributions not used for qualifying expenses
into income in the year of the distribution, rather than amending his returns for the years
the contributions were made to disallow the subtractions.
March 13, 2012
Dear:
This is in response to your letter dated February 20, 2012 regarding Illinois income tax. The nature of
your letter and the information provided require that we respond with a General Information Letter
(GIL). A GIL is designed to provide general information, is not a statement of Department policy and
is not binding on the Department. See 86 Ill. Adm. Code 1200.120(b) and (c), which may be accessed
from the Department’s web site at www.ILtax.com.
Your letter states as follows:
We are writing this letter to address an issue we came across with an Illinois resident taxpayer
regarding the income recapture of deductions previously claimed for contributions to a 529 Plan.
During the tax years from 2007 to 2010, the taxpayer made contributions to IL Bright Start 529 plans
which were treated as subtractions on his Illinois return, Schedule M, in the corresponding years at
which time the IL tax rate was 3%. Due to unforeseen circumstances and the nature of the taxpayer’s
new business starting 2011, now a self-employed partner of a public accounting firm, he was forced
to involuntarily liquidate his capitals from IL qualified education plans. Due the very strict
independence rules that a partner in a public accounting firm has to endure, he could no longer keep
his IL Bright Start plans.
Given the fact that the IL tax rate increased to 5% beginning in the 2011 tax year, the year in which
he withdrew the funds, he would technically have to claim the recapture of the distributions as an
addition on his 2011 Illinois return, Schedule M, and would be liable to pay a 5% tax rate on the entire
amount albeit he received only a 3% tax break on each respective prior year returns. In order to
mitigate paying the 2% tax difference, the taxpayer is willing to amend his 2008, 2009 and 2010 IL
returns without claiming the deductions he originally claimed in prior years.
Before taking this route, we wanted to contact you to respectfully request the possibility of the
abatement of any interest and penalties, resulting from amended prior year returns, from the IL
Department of Revenue based on the facts and circumstances listed above? If not, are there or will
there be provision in the 2011 IL tax laws which will allow the taxpayer to be taxed at a 3% rate in this
circumstance, the same rate in which he received the related deductions in the prior years, as a result
of his involuntary withdrawals during 2011?
RULING
Section 203(a)(2)(Y) of the Illinois Income Tax Act (“IITA” ; 35 ILCS 5/203) provides a subtraction
modification to adjusted gross income for moneys contributed to an Illinois Bright Start account.
Section 203(a)(2)(D-22) provides:
For taxable years beginning on or after January 1, 2009, in the case of a nonqualified withdrawal or
refund of moneys from a qualified tuition program under Section 529 of the Internal Revenue Code

IT 12-0004-GIL
March 13, 2012
Page 2
administered by the State that is not used for qualified expenses at an eligible education institution,
and amount equal to the contribution component of the nonqualified withdrawal or refund that was
previously deducted from base income under subsection (a)(2)(Y) of this Section, provided that the
withdrawal or refund did not result from the beneficiary’s death or disability.
Based on the information contained in your letter, there is no basis upon which to amend the
taxpayer’s 2008, 2009, or 2010 Illinois tax returns. During tax years 2008 to 2010, the taxpayer in fact
contributed moneys to Illinois Bright Start accounts. Therefore, the subtraction modification under
IITA Section 203(a)(2)(Y) applies to those contributions. Based on your letter, then, the taxpayer’s
returns for those taxable years are correct as filed. In 2011, the taxpayer made a nonqualified
withdrawal of those contributions. Therefore, the addition modification under IITA Section
203(a)(2)(D-22) applies. The taxpayer’s 2011 return must include that addition modification.
Unfortunately, the IITA does not contain a provision to remedy the fact that the tax rate was only 3%
during the taxable years in which the subtraction applied, but 5% for the taxable year in which the
addition applies. The opposite of this situation may occur in the future as the 5% tax rate begins to
phase out in taxable year 2015, but likewise without remedy.
As stated above, this is a GIL. A GIL does not constitute a statement of policy that applies, interprets
or prescribes the tax laws, and it is not binding on the Department. If you have questions regarding
this GIL you may contact Legal Services at (217) 782-7055. If you have further questions related to
Illinois income tax laws, visit our website at www.revenue.state.il.us or contact the Department’s
Taxpayer Information Division at (217) 782-3336.

Sincerely,

Brian L. Stocker
Staff Attorney (Income Tax)