Many states offer tax deductions or credits to taxpayers who contribute to a Section 529 plan. However, one of the little-known specifics of these plans is that certain states do not have any minimum time requirements for plan contributions. This translates to a taxpayer investing a significant part of their normal savings into a 529 plan for the sole purpose of taking a distribution of the same amounts in days or weeks, instead of years.
What does the taxpayer gain? The tax benefits the state makes available to them is still viable, even though there was a short time the plan actually existed. So, the taxpayer who planned on paying a bill for college with their normal savings can now take a slight investment detour and reap the benefits without much time and effort.
When a taxpayer or their dependents earn a scholarship from a qualifying institution, and also have qualifying educational expenses, the amount of the scholarship is tax free, as long as the amounts were used to pay for those expenses. Of course, the expenses would then be ineligible for use in calculating any possible educational credits, such as the American Opportunity Credit. Note these credits can be valuable; and instead, it may very well make sense to apply the scholarship to a non-qualifying expense, such as room and board, and pay the tax on the scholarship income.
In most circumstances, the tax credits will yield a more favorable result than the inclusion of scholarship income, especially when the dependent, and not the person claiming the dependent, must report the income.
With some targeted planning, the magnitude of dealing with escalating higher education expenses can be mitigated. The current tax law has always favored the pursuit of higher education, and allows for some significant credits and deductions.