You can deposit your tax refund and continue to keep on saving throughout the year. Many 529 plans offer affordable monthly contribution limits as low as $25 that can be automatically how to report 529 distributions on tax return deposited straight from your checking account. If you’re expecting a tax refund check this year, it can be tempting to take a lavish vacation or go on a spending spree.
- Unlike an IRA, contributions to a 529 plan are not deductible and therefore do not have to be reported on federal income tax returns.
- A Form 1040 return with limited credits is one that’s filed using IRS Form 1040 only (with the exception of the specific covered situations described below).
- If you have many withdrawals or expenses, you should also keep a spreadsheet listing each expense, what it was for, the cost and when you bought it.
- That means being aware of qualified and non-qualified expenses, options for leftover funds, and penalties.
But, you cannot withdraw the remainder penalty-free in a subsequent year, since distributions must be made in the same tax year as the scholarship was used to pay for qualified higher education expenses. You should keep documentation relating to the scholarship in case your federal income tax returns are audited. Documentation may include a copy of the scholarship award letter, a copy of the scholarship check and a copy of IRS Form 1098-T issued by the college. When you have 529 plan funds that are distributed to the account owner or the beneficiary instead of directly to the college, it’s crucial to keep a record of how you spend it.
Parents can make 529 withdrawals by completing a withdrawal request form online. Some plans also allow 529 plan account owners to download a withdrawal request form to be mailed in or make a withdrawal request by telephone. Additionally, some parents have multiple 529 accounts for a few reasons. Most often, a parent may prefer an out-of-state 529 plan over the in-state 529 plan but does not want to forsake the state tax deduction in states offering that particular benefit.
How do scholarships impact 529 plan withdrawals?
If someone has contributed money to a 529 plan or a Coverdell Education Savings Account (Coverdell ESA) and designates you as the beneficiary, they will receive an IRS Form 1099-Q when they start tapping into those funds. When someone receives a 1099-Q each year, it may be necessary to include some of the amounts it reports on their tax return. Form 1099-Q lists the total distributions from a 529 plan or Coverdell ESA during a given calendar year, regardless of how the beneficiary or account owner spent the funds. Typically, Box 1 of Form 1099-Q lists the total distribution, Box 2 includes the earnings portion of the distribution, and Box 3 includes the basis, which is the contribution portion of the distribution. The account owner of a 529 plan can change the beneficiary to be themselves and then take a qualified distribution to repay their own student loans. The person who receives the funds (whose SSN is on the 1099-Q ) has to report the Form 1099-Q on their tax return (If the money went straight to the school, it is treated as going to the student).
Impact of Free Tuition on 529 Plans
The total dollar amount entered from each portfolio should equal the total amount of the distribution. If you withdraw the 529 money in December for a tuition bill that isn’t paid until January, you risk not having enough QHEE during the year of 529 withdrawal. Likewise, if you take a distribution in January to pay for expenses from the previous December, that distribution will be a non-qualified distribution. On the flip side, 529 plans also have ineligible expenses, defined by the IRS as room and board, travel, research, clerical help and other expenses, such as equipment, that are not required for enrollment or attendance at an eligible school. Today we’re tackling the next (and probably most dreaded) step of your educational savings journey– figuring out if and how you need to report your 529 distribution on your tax return.
This way, the beneficiary receives the Form 1099-Q and the IRS computers don’t send up red flags. When the beneficiary enrolls in school and starts taking distributions to pay school expenses, the account manager will begin sending Form 1099-Q each year. And as long as the distributions are used to pay only qualified education expenses, the recipient doesn’t pay income tax on the distributions. Suppose the beneficiary receives a tax-free scholarship, fellowship grant, Veteran’s educational assistance, employer-provided assistance, or other tax-free educational assistance. In that case, the payment amount must also be subtracted from the total qualified expenses. Beneficiary tax implications For most qualified education program beneficiaries, the amounts reported on the 1099-Q aren’t reported on a tax return.
Families can also take a tax-free distribution to pay for tuition expenses at private, public and parochial elementary and high schools. The SECURE Act of 2019 expanded the definition of qualified 529 plan expenses to include costs of apprenticeship programs and student loan repayments. Qualified distributions for student loan repayments have a lifetime limit of $10,000 per beneficiary and each of their siblings.
Options for Unused 529 Plan Funds
Examples include Pell grants, tax-free scholarships and fellowships, tuition discounts, the Veteran’s Educational Assistance Program, and tax-free employer educational assistance programs. Once the value of a beneficiary’s account (or accounts) exceeds the plan’s allowable limit, there is no requirement that the excess be refunded. Instead, further contributions to the plan for the benefit of the designated beneficiary are not allowed. If the aggregate account balances later decline below the limit, contributions are presumably once again allowed. QTP contributions on behalf of any beneficiary can’t be more than the amount necessary to provide for the qualified higher education expenses of the beneficiary. Contact the program’s trustee or administrator to determine the program’s contribution limit.
Room and board is also included if the student/beneficiary attends at least half of the time. Qualified expenses also include expenses of special-needs services for special-needs beneficiaries. If you receive more in a 529 annual distribution than the amount of your adjusted qualified educational expenses, the amount of earnings reported in Box https://turbo-tax.org/ 2 of your 1099-Q may be subject to federal income tax. When the Form 1099-Q is issued to the 529 plan beneficiary, any taxable amount of the distribution will be reported on the designated beneficiary’s income tax return. This typically results in a lower tax obligation than if the Form 1099-Q is issued to the parent or 529 plan account owner.
For example, you can’t use those funds for transportation, health insurance, or miscellaneous living expenses. However, ensure you use your withdrawals for that year’s qualified expenses. You also have to make sure that you withdraw your funds at the right time to align with when you’re going to be using the funds. However, colleges often receive checks for outside scholarships won by their students, and they will typically reduce the student’s federal, state and institutional need-based grants by an equivalent amount.
However, the new, simplified FAFSA form will eliminate the grandparent financial aid trap. The updated FAFSA will not require students to report cash report, including money from grandparents. So, any distributions that a grandparent takes from a 529 plan in 2022 or later (due to prior-prior reporting) will not be included in the student’s financial aid calculations on the FAFSA. Note, however, that grandparent support is still considered on the CSS Profile form. It’s up to the 529 plan account owner to calculate the amount of the tax-free distribution and how they want to receive the funds.
State-sponsored plans do not guarantee 529 education savings plan investments, although some 529 plan investments in bank products may be insured by the Federal Deposit Insurance Corporation. A 529 plan is an investment, which carries investing risks just as other types of investments do. The SEC urges potential 529 plan investors to perform their due diligence by reading all the details contained in a 529 plan’s offering circular before making their investment decision. Typically, the earnings portion of a distribution will be about 10% to 30% of the total. The tax penalty will then be 10% of this amount, or just 1% to 3% of the distribution amount. That may be the equivalent of just a few months’ earnings, similar to the 3-month interest penalty on early withdrawal from a bank CD.
You can choose to have the money sent directly to the school, the account owner or the beneficiary. Since the money was used for qualified expenses, none of it is taxable. The simplest thing to do is just don’t enter the 1099-Q in TurboTax (TT). With careful planning, you can avoid having money left over in your 529 account once your child graduates. You can let the money sit in the account in anticipation of your child continuing on to graduate school or another post-secondary institution. If so, you’ll want to rethink your investment strategy depending on how soon the funds will be needed so you can take full advantage of the potential for growth over time.
Reporting 529 Nonqualified Distributions
While the earnings of all non-qualified withdrawals are subject to tax (as with any regular investment), there are instances where you won’t be subject to the 10% penalty. Military Academy, tax-free educational assistance, receipt of education tax credits, the return of excess funds that were previously withdrawn in error, death or disability. The two most common types of qualified education programs are state-sponsored 529 plans and Coverdell ESAs. Both types of accounts allow the account owner to set aside money to cover the qualified education expenses for the person who is designated as the beneficiary.
The 10% tax penalty on the non-qualified distribution will be waived up to the amount of the scholarship, but the earnings portion of the non-qualified distribution will still be taxed as income. If you miss the 60-day cutoff, then the excess will be treated as an unqualified withdrawal and you’ll owe income taxes and the 10% penalty. You’ll eventually be asked what level of school the student attended and finally be given a screen to enter the expenses paid. The fact that the expenses were paid indirectly does not change the fact that the 529 plan was used for qualified expenses.
