16 states might tax federally approved education plans

Audio By Carbonatix

(The Center Square) – Families in 16 states could face state taxes and penalties for using what's called a "529 education savings plan" to pay for expenses approved under federal law, according to a report from the American Legislative Exchange Council. 

Congress established the 529 education savings plan in 1996 through the Small Business Job Protection Act. The 529 plan allows a family to save for qualified education expenses, including certain costs associated with K-12 education and higher education, according to Fidelity. The families save money through tax-deferred investments.

ALEC released its report Wednesday, "Building a Better Path to Education: State 529 Laws After the Working Families Tax Cuts," examining differences between federal rules governing qualified education expenses and state policies.

According to the report, 11 states - California, Colorado, Delaware, Hawaii, Illinois, Michigan, Minnesota, Nebraska, New York, Oregon and Vermont - do not allow 529 funds to cover any K-12 expenses under their state rules.

Arkansas, Kentucky and Louisiana allow funds to cover K-12 tuition, but only up to $10,000 annually. Indiana and Montana allow K-12 tuition expenses up to $20,000 annually but do not permit the full range of expenses authorized under federal law.

The Center Square reached out Wednesday to ALEC for an interview, but did not hear back by publication time.

Lance Izumi, senior director of the Center for Education at the Pacific Research Institute, told The Center Square that these states are not aligning with federal law over these eligible K-12 expenses because states with strong teacher unions oppose school choice. 

“Politicians in places like California and other states are putting their special interest allies ahead of the interests of children and parents," Izumi told The Center Square. 

"Families should not face a state tax penalty simply because they use their education savings for an expense that Congress has already authorized," Izumi added.

As of the end of 2025, the 529 plans held 4.7 million accounts in the U.S. with $161.3 billion in assets under management, according to the report. ALEC’s report highlights what the council calls the importance of ensuring state laws align with federal rules over eligible expenses.

“Parents should have the freedom to use their hard-earned education savings in ways that best meet their children's needs,” said ALEC CEO Lisa Nelson in a statement. “Congress has expanded the opportunities available to families through 529 savings plans, but too many states continue to impose burdensome restrictions. State lawmakers have an opportunity to remove these barriers and ensure families can take full advantage of the educational choices available to them.”

The U.S. is currently at $1.9 trillion in student loan debt, according to the Education Data Initiative. With the cost of higher education increasing, 529 plans are ways for parents to plan and set their children up for financial success within education. 

Signed into law in 2025, the Working Families Tax Cuts, out of President Trump’s One Big Beautiful Bill Act, doubled the annual limit for qualified K-12 expenses from $10,000 to $20,000. The law expanded eligible expenses to include instructional materials, educational therapies for students with disabilities, among other things. 

ALEC said state laws in 16 states have not fully aligned with the expanded federal rules, potentially leaving families exposed to state tax liabilities and penalties.

For example, California may impose state income taxes and an additional 2.5% tax penalty on families who use 529 funds for K-12 expenses that qualify under federal law but not under state rules.

ALEC's report recommends that states align their 529 statutes, income tax rules and program guidance with the full federal definition of qualified expenses.

“Families should not face a state tax penalty simply because they use their education savings for an expense that Congress has already authorized,” said Andrew Handel, report author and director of ALEC’s Education and Workforce Development Task Force in a statement.