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Tax Recapture - Definition and Overview of Tax Recapture

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Definition:

A tax recapture happens when a taxpayer is required to go back and pay taxes on a situation where a tax deduction or tax credit had previously lowered their taxable bill.

In college planning situations, this occurs most often when a non-qualified distribution is taken from a Section 529 plan that a taxpayer had previously claimed a tax benefit for contributing to.

Since there is no Federal income tax deduction for contributing to Section 529 plans, a tax recapture happens only if the account owner lives in a state that permits a deduction on a taxpayer's state income tax return. Currently, there are over 30 states that allow a deduction for contributing to a Section 529 plan.

Disqualified distributions subject to a tax recapture generally include any distribution that is not for higher education purposes, often even including a rollover to another state's Section 529 plan.

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