02 Mar Are these college savings really taxable in New Jersey?

Q. When my daughter was born 18 years ago, I contributed to a Coverdell education savings account. It seems New Jersey is the only state in the union where the earnings portion is taxable. Is this correct? I should have used a 529 plan. What’s the deal?
— Dad

A. You’re correct that New Jersey treats Coverdell accounts, previously known as Education Savings Accounts (ESAs), differently than 529 plans.

Had you chosen the 529, it would have received the same tax-free results for New Jersey as it would federally.

Bulletin GIT-2 addresses New Jersey’s tax treatment of Coverdell education savings accounts, said Neil Becoutrney, a certified public accountant and tax partner with CohnReznick in Holmdel.

Contributions to Coverdell ESAs are not deductible when they are made, like regular IRA contributions, he said. So this creates a “basis” that is returned tax-free.

“Distributed earnings from a Coverdell ESA are subject to New Jersey tax,” he said. “Although you will recover your basis tax-free, there is no formal guidance as to how it is recovered when you take distributions, which presumably include a portion of what you contributed as well as the taxable earnings.”

For federal purposes, Becourtney said, withdrawals from a Coverdell ESA are tax-free if used for qualified education.

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This story was originally published on March 2, 2020.

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