Hawaii and 15 other states may tax federally approved 529 education expenses

The American Legislative Exchange Council released a report on Wednesday detailing how 16 states may levy taxes or penalties on families using 529 education savings plans for federally authorized K-12 expenses. The document, titled Building a Better Path to Education: State 529 Laws After the Working Families Tax Cuts, maps the divergence between federal statutes and state-specific restrictions.

The 529 plan was established by Congress in 1996 through the Small Business Job Protection Act. It allows families to invest with tax deferral for qualified education costs. As of the end of 2025, these accounts held 4.7 million open positions and $161.3 billion in assets under management in the United States.

The report identifies 11 states that currently prohibit the use of 529 funds for any K-12 expenses under state rules. These states are California, Colorado, Delaware, Hawaii, Illinois, Michigan, Minnesota, Nebraska, New York, Oregon, and Vermont. Another five states impose annual caps or limit the specific types of expenses covered.

Arkansas, Kentucky, and Louisiana allow 529 funds to pay for K-12 tuition, but state rules cap the amount at $10,000 annually. Indiana and Montana permit K-12 tuition expenses up to $20,000 per year, though they do not authorize the full range of federal expenses.

The federal Working Families Tax Cuts, signed into law in 2025 as part of the One Big Beautiful Bill Act, doubled the annual limit for qualified K-12 expenses from $10,000 to $20,000. The legislation also expanded eligible costs to include instructional materials and educational therapies for students with disabilities. ALEC states that 16 states have not yet updated their laws to reflect these changes.

Lisa Nelson, CEO of ALEC, stated that parents should have the freedom to use their education savings in ways that best meet their children's needs. She added that Congress expanded opportunities through these plans, but many states continue to impose restrictive barriers. Andrew Handel, director of ALEC’s Education and Workforce Development Task Force and the report's author, said families should not face state tax penalties for using savings on expenses Congress has authorized.

California serves as a primary example of the potential financial impact. The state may impose 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 California rules. The report recommends that states align their statutes, income tax rules, and program guidance with the federal definition of qualified expenses. The U.S. currently holds $1.9 trillion in student loan debt, according to the Education Data Initiative.