September 27-28, 2001

Explanation of Proposed Policy Changes for the
Montana Family Education Savings Program



The proposed changes in the policy promulgated by the Board of Regents ("BOR") for the Montana Family Education Savings Program (the "Program") generally are attributable to recent changes in state and federal law. Earlier this year, the Montana legislature passed and the Governor signed Ch. 468, L 2001, amendments to the laws governing family education savings accounts (the "Montana Amendments"). The federal Economic Growth and Tax Relief Reconciliation Act of 2001 (the "Federal Tax Amendments"), which President Bush signed in June, made numerous amendments to section 529 of the Internal Revenue Code, the provision governing qualified State tuition programs, such as the Program.

Montana Amendments

The Montana Amendments require Montana residents to recapture deductions claimed for contributions to accounts opened after April 30, 2001, if the contributions are withdrawn within three years of the date the account is opened. This provision makes it more difficult for Montana residents to funnel dollars to pay higher education expenses through accounts for the sole purpose of obtaining a tax deduction. Section III(A)(4) of the BOR rules now attempts to stop such behavior by imposing a $100 fee on withdrawals from accounts that have been open for less than three years. The proposed amendments would repeal the BOR rule effective for accounts opened before May 1, 2001, because the rule is no longer needed [section III(A)(4)].

To reflect the Montana Amendments, the proposed amendments also:

  • include a reference to the Montana Amendments [section II(A)(3)].
  • change a reference to the section of the Montana Code that provides the deduction for contributions to accounts [section III(I)(1)(c)].
  • refer to the Montana deduction as a "deduction" rather than an "exclusion" [section III(I)(1)(c)].
  • eliminate language that is no longer needed because the Montana Amendments conform the definition of "higher education institution" and "member of the family" to the corresponding federal tax definitions [section II(A)(12) and (14)].

Federal Tax Amendments

Under federal income tax law in effect today, a qualified State tuition program must impose more than a de minimis penalty on account earnings withdrawn in nonqualified withdrawals. The Federal Tax Amendments repeal this requirement effective January 1, 2002, and impose an add-on federal tax equal to 10% of the earnings withdrawn and not used to pay qualified higher education expenses (unless withdrawn on account of the death, disability or scholarship of the designated beneficiary). The proposed amendments would repeal the 10% Montana penalty on earnings withdrawn in nonqualified withdrawals after December 31, 2001, to avoid duplicate penalties [section III(F)(12)(a)].

Section III(F) of the BOR rules includes provisions intended to help the Program Manager determine whether withdrawals are qualified or nonqualified withdrawals for purposes of the Montana 10% penalty and to facilitate collection of the penalty. These provisions are not needed if the penalty is repealed. The proposed amendments generally repeal these provisions [section III(F)(12)(b)]. However, the provisions would continue to apply to the extent that the BOR or the Program Manager determines that they are needed to comply with federal income tax reporting requirements [section III(F)(12)(b)(ii)]. The repealed provisions would also continue to apply to accounts owned by Montana residents to the extent required by the Montana Department of Revenue to facilitate the payment of the recapture tax on nonqualified withdrawals of deductible contributions [section III(F)(12)(b)(iii)].

All of the Federal Tax Amendments cease to be effective ("sunset") on December 31, 2010. Although the provisions relating to qualified State tuition plans are unlikely to sunset, the proposed amendments reinstate the repealed provisions if the Federal Tax Amendments sunset [section III(F)(12)(c)].

Certain technical changes are need in the BOR rules to reflect changes that the Federal Tax Amendments make in section 529 of the Internal Revenue Code effective January 1, 2002. The proposed amendments:

  • change a cross reference to a paragraph of the Internal Revenue Code to reflect renumbering of the paragraphs of section 529(b) [section II(D)(3)].
  • reflect the repeal of the provision in section 529 of the Internal Revenue Code containing the cross-referenced term "scholarship" [section II(A)(21)].
  • reflect the renaming of "qualified State tuition accounts" as "qualified tuition accounts" [section II(A)(19)].


Other Changes

The present BOR rules do not specifically allow for spouses to jointly own an account. The proposed amendments would permit spouses to jointly own accounts [section III(C)(2)] and make related changes to permit changes of account ownership to joint ownership [section III(G)(3)(c)] and clarify that if a joint owner an account dies, the other joint owner becomes the sole owner [section III(G)(3)(d)].

The proposed amendments make purely technical changes in the following sections:

  • Section II(A)(15).
  • Section II(A)(18).
  • Section II(A)(23).
  • Section III(G)(3)(a).