529 withdrawals, tax credits questions

Paying for College
1

<p>Is there any benefit to withdrawing funds from a 529 and having them sent directly to a school over getting a check and forwarding it on? Is it better for tax purposes? </p>

<p>I noticed that the options to withdraw for higher learning include sending $$ directly to the school, a check to me and a check to the beneficiary.</p>

<p>Also - does anyone know if the current tax credit allowed for college expenses apply to $$ withdrawn from a 529 and whether having those funds paid directly from the fund or via a check to the account owner (me) matter?</p>

<p>In our case this likely won't matter since there will be loans and I've read that loans (even if deferred) qualify as payment for the purposes of tax credits.</p>

<p>Thanks</p>

2

<p>I have the exact same questions!</p>

3

<p>I don’t know if all states are the same, but in NY, we were told by our accountant that money paid from a 529 cannot be used for tax credit, because we already received a tax benefit by putting the money into a 529 to begin with (tax benefit when putting it in and compound interest that has no tax consequences when taken out.)</p>

<p>Our accountant said only money we paid separately from our own account gets the tax credit.</p>

4

<p>You may want to suggest your accountant thoroughly reads IRS 970. You can pay taxes and no penalty on the 529 withdrawal and use the expenses for the tax credit.</p>

<p>IRS 970 page 55</p>

<p>

[quote]
Coordination With American Opportunity and Lifetime Learning Credits:
An American opportunity or lifetime learning credit (education credit) can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits. This means that after the beneficiary reduces qualified education expenses by tax-free educational assistance, he or she must
further reduce them by the expenses taken into account in
determining the credit.
Example 2. Assume the same facts as in Example 1, except that Sara’s parents claimed an American opportunity credit of $2,500 (based on $4,000 expenses).
Total qualified education expenses $8,300
Minus: Tax-free educational assistance −3,100
Minus: Expenses taken into account in figuring American opportunity credit −4,000
Equals: Adjusted qualified education expenses (AQEE) $1,200
The taxable part of the distribution is figured as follows.
$1,200 AQEE 1. $950 (earnings) </p>

5

<p>Aparentalunit–we are also in NY and that makes a lot of sense, finally, because on another thread several months ago, someone was discussing not contributing to a 529 and therefore getting a tax credit via yearly tax returns and I didn’t quite understand it. </p>

<p>I was also wondering if it paid to keep contributing to the 529 now for the next 3 years. I think one would need to be a computer to try to figure out the best tax situation–contributing to 529 and getting the tax benefit on our NY returns + no tax on the dividends or no contributions and getting the 1040 tax return benefits. Maybe when it’s not 10:30 at night I could figure this out lol!</p>

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<p>Note that only the EARNINGS portion of a 529 withdrawal(distribution) is taxable. The earnings portion is likely to be a small percentage of the total distribution, depending on how long the money has been in the account, what investment option it’s been in and how well (or poorly) the investment has done. When you take a distribution, the records from the 529 plan will show how much of it is earnings - for example, from my kids account: distribution of $2500 on 12/18/09 - $2487.96 listed as “qualified contribution”, only $12.04 listed as “qualified earnings”. Therefore, if I made a withdrawal in excess of qualified expenses, or was “double-dipping” by counting 529 funds toward the AOCredit, I would only owe taxes on the $12.04. </p>

<p>We have 2 kids in college. We’re funneling as much money as possible through the 529 in order to get the state income tax savings. In our state, funds must only be in the account 10 days before they can be withdrawn, and up to $20,000 of contributions are exempt from state income tax for couples married filing jointly (there’s also some provision that excess contributions can be deducted from state tax in a certain number of subsequent years - I may need to check on the details if we are able to contribute more than $20K this year). It’s all in the “guaranteed” option, which pays about 3% annually, and has no risk whatsover.</p>

<p>Saved us $1100 in state income tax last year - every little bit helps!</p>

<p>Something else to note - if you get financial aid from a meets-full-need school and will be getting a significant reduction in state income tax, adjust your state withholding so that you get NO or minimal refund. This is because, for those who itemize, refunds of state income tax are added to income and become part of AGI. FAFSA will take 47% of any additional AGI and add it to your EFC, effectively leaving you with only half of your state refund. Again, every little bit helps.</p>

7

<p>Your point about state refunds-- again something I had not thought about and yes, we do usually get a refund that increases our AGI. Now I have another thing to figure out how to adjust!</p>

<p>RE: 529 distributions-- I thought the law had been changed so that withdrawals were tax free if used for qualified expense expenses. In fact, I thought I just read that on a thread today. I mean what else would I withdraw the money for if not for education expenses? I’m still trying to figure out the fed tax credit for tuition expenses (hope credit or whatever they are calling it now) vs making the 529 contributions. According to other threads, since one has already gotten a tax advantage by contributing, one cannot take the credit. Now I am confused. I have an accountant who has a D going to college next year and one just finishing and she doesn’t seem to know the answer to this question (guess I’d better get a new accountant!).</p>

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<p>They are tax free if you use them for qualified expenses. They have been for years. </p>

<p>But you can’t use the same expense for two separate tax benefits. So if you use a $2000 expense to make a 529 account withdrawal tax free, you can’t use the same expense to claim a tax credit.</p>

<p>But the definition of qualified expenses for 529 account withdrawals is much broader than for other tax benefits. For instance you can uses 529 account money for room and board.</p>

9

<p>From the Fin Aid website-
“The Hope Scholarship and Lifetime Learning tax credits can be claimed in the same year that you take a tax-exempt distribution from a section 529 plan or a Coverdell Education Savings Account, but the distribution may not be used for the same qualified higher education expenses.
Tax-free distributions can be taken from both the Coverdell Education Savings Accounts and a 529 plan in the same year, but the distributions may not be used for the same qualified higher education expenses.”</p>

<p>So theoretically it sounds like if I continue to contribute to D’s 529 and I want to take the Hope Credit on our taxes, I can only use 529 withdrawals for room and board so that the Hope can be credited against tuition. Correct?</p>

<p>So since I will need most if not all of D’s 529/coverdell in the first year for all expenses, I won’t be able to take any Hope Credit. Correct?</p>

<p>Momcat2 - If I double dipped and took the full Hope Credit the first year are you saying I’d only have to pay tax on the earnings, as in paying tax is like a penalty for double dipping?</p>

10

<p>finaid is a bit out of date. The hope credit does not exist any more. it is now the American opportunity Credit.</p>

<p>The IRS publication for education tax credits is IRS 970. It contains all the rules about when scholarships and grants are taxable, what expenses are eligible for the tax credits, what expenses are eligible for tax free treatment of 529 account withdrawals. You can choose which tax benefit to take based on which is more beneficial for you. But you can’t double dip - ie you can’t use the same expense for more than one tax benefit. </p>

<p>Post #4 above includes quotes is direct from the IRS publication and detail how you can coordinate 529 account withdrawals and the American opportunity credit.</p>

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<p>upstatemom, only $4000 of qualified expenses (in this case, only tuition, mandatory fees and required books, supplies and equipment) count toward the American Opportunity Credit. So you will likely have some “left over” expenses in these categories that can be paid for with 529 funds. Plus, as mentioned by others, 529 funds can also be used for room and board (and in 2009 and 2010, they could also be used for computer expenses).</p>

<p>Pub 970, and swimcatsmom’s post #4, which quoted from it, is very helpful, as swimscatsmom just mentioned. (and thanks, swimcatsmom, for the quote that stated that “The 10% additional tax does not apply to distributions: 5. Included in income only because the qualified education expenses were taken into account in determining the American opportunity or lifetime learning credit”. I did not know (or had forgotten) that.)</p>

<p>And yes, upstatemom, if you double-dipped, or otherwise took a withdrawal for something other than qualified educational expenses, only the EARNINGS portions is subject to tax. As quoted by swimcatsmom from Pub 970, in the case of “double-dipping” with 529 funds and the AOCredit, only your regular tax rate (and not the 10% penalty) would apply, and only on the earnings portion. This is, I assume, because (at least for federal taxes) 529 contributions come from AFTER-tax dollars. (deductability from state income tax varies widely from state to state.) There are some other circumstances, all mentioned in IRS Pub. 970, which also exempt you from the 10% tax penalty.</p>

12

<p>There is so much in 970, it is easy to miss something. This year is the first time I have noticed the part about the penalties not being applied if you are just paying tax because of using the withdrawals to claim the credit. I thought perhaps it was new, but looked at the 2009 version and it was in there as well.</p>

<p>I find it a little disturbing when people’s accountants don’t know this stuff, or at least know where to go to find it out!!</p>

13

<p>Can anyone confirm that using a 529 for a computer purchase is completely out for 2011?</p>

14

<p>Why do you think you can’t use a 529 for a computer purchase? Mine says "money from your account in New York’s 529 College Savings Program Direct Plan can be used to pay for tuition, fees, books, certain room-and-board expenses, supplies, and other qualified higher-education expenses at any eligible postsecondary school in the United States and abroad. This includes most colleges, universities, graduate schools, and vocational schools. "</p>

<p>I consider a computer a supply – I’ve sent them an email to doublecheck.</p>

<p>Also - I wonder if we take out loans and find we have enough in loans to pay for school – if we can use the $$ in the 529 to pay off the loans after the fact. I figure if the loans are subsidized and interest free until my child starts paying them back – we should take them out in case we’re caught short. Does anyone know if you can do this?</p>

15

<p>rachelfran – I am in NY too. The next line after your excerpt from the plan description is: “For 2009 and 2010 only, assets in your account can be used to pay for expenses paid or incurred for the purchase of any computer technology or equipment or Internet access and related services, if such technology, equipment or services are to be used by the Beneficiary and the Beneficiary’s family during any of the years the Beneficiary is enrolled at an eligible educational institution. Expenses for computer software designed for sports, games, or hobbies, are not included unless the software is predominantly educational in nature.”</p>

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<p>You need to withdraw the 529 funds during the calendar year they are used to pay for qualified higher education expenses. So if you take out a loan for year 1 of college, you can’t withdraw the 529 funds in year 4 to pay off the year 1 loans. Well, you can, but you’re subject to penalty and tax on the capital gains.</p>

<p>You can always change the beneficiary of a parent-owned 529. If you have another child who can use the funds, you could take out loans for child 1 and transfer child 1’s 529 to child 2.</p>

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<p>In the past,we have been over the income limit to use any tuition tax credits, but contributed to a 529 in order to take the state tax deduction. In 210 however, our income is below the limit. We contributed $25,000 to a 529 in 2010 and withdrew $35,000 paid directly to the school for tuition, RB for fall '10 and spring '11. The end of year statement showed minimal earning on the contribution ( in MM fund for short time). The 1098t from school was for $25,000 (fall '10 and spring '11 tuition). I used $500 for books for the AOC on taxes. Is this correct? </p>

<p>Do I understand correctly from this discussion that I add only the earnings from the 529 to the federal tax return on line 21, and take the 1098T tuition paid to use for the AOC? If so , what about the fact that I used the state deduction? I know that each year I add the state refund I received ( from making 529 contribution) back to my federal return.</p>

<p>Also, for next year, if I know income will still be below the limit for AOC, should we only contribute monies to the 529 to cover room and board? I am so confused!</p>

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<p>I am with you on that. I will most probably withdraw from my 529 to cover the gap and I have no idea about the tax impacts. I guess I will have the CPA figure it out.</p>

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<p>mabel - the 1098T will only show the amount billed (or perhaps paid) for tuition and required fees (it will NOT include room and board. Nor, of course, will it include amount paid for required books, supplies and equipment, or - if applilcable - for a computer)</p>

<p>IMPORTANT – You take the AOC (provided you meet the income requirements) only for <strong>THE FIRST $4000</strong> that you paid for tuition, required fees, and required books/supplies/equipment.</p>

<p>How much did you pay TOTAL <strong>in 2010</strong> for tuition, required fees, ALL required books/supplies/equipment, ROOM and BOARD, and a computer(plus software -except for games- and internet access for the student)? Call this total “A” (529 withdrawals can include room and board, PLUS, for 2009 and 2010 only - computer expenses. Eligible expenses for the AOC include only the things I listed in my previous paragraph) </p>

<p>You withdrew $35K from the 529. Is this greater or less than Amount A? (sounds like it’s at least $500 less, since you mentioned $500 spent for books).</p>

<p>IF (A - $35000) is greater than $4000, then you can take the full AOC and not owe any tax on the 529 withdrawal (since there was no “double-dipping” - ie, the $4000 of eligible AOC expenses are “separate” from the 529 withdrawal).</p>

<p>If there is any overlap between the $4000 of expenses used for the AOC and the $35K 529 withdrawal - in other words if [A - $35000] is LESS than $4000 -(remember to include all books/supplies/equipment and the purchase of any computer or computer equipment/supplies/software), then you would only consider for tax the amount of overlap (or double-dipping), which would be a max of $4000(but in your specific case, a max of $3500, because of $500 for books). </p>

<p>Let’s say you had an overlap (or double-dip) of $3000. Each time you withdrew from the 529, your statement should say how much of that was earnings and how much your contribution(or principle). You would only owe tax on the PORTION OF $3000 THAT WAS EARNINGS. See p. 55 of IRS Pub. 970 for an example of how to figure this. </p>

<p>[Their example 1 is a scenario where $100 extra was taken out of the 529 (“QTP”, in IRS parlance), no AOC was claimed. The family had made approx 18% in earnings on the 529 distribution (950/5300), therefore only $18 of the “excess” $100 was taxable. Example 2 is the same as #1 except that the family used $4000 of qualified expenses to get the max $2500 AOC credit. So now they had $4100 of “excess” 529 withdrawal - the example calculates how much is taxable, ie how much of the earnings, as the IRS puts it, were “not used for adjusted qualified education expenses”.]</p>

<p>Something I just thought of - if you paid a tuition deposit, and/or a room deposit in 2010, don’t forget to include these in calculating the amount you paid in 2010.</p>

<p>If you’re still confused after reading p. 55 of Pub. 970, list the amounts here and I can help you figure the taxable amount. (I may be gone from my computer this afternoon, but will be back eventually :slight_smile: )</p>

<p>Many tax preparers (even accountants) don’t seem to know jacks**t about Pub. 970, so I think you’re better off educating yourself. The tax software (turboTax, etc.) also doesn’t seem to do too well with the nuances of 529s, the AOC, taxable portion of scholarships/grants, etc.</p>

<p>[on edit - forgot to credit swimcatsmom for first posting those examples from p. 55 of Pub 970 in her very informative post #4 on the first page of this thread!]</p>

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<p>MomCaT2-THANK YOU for taking the time to to write a detailed explaination to my question. I did read Pub 970, page 55, could not understand it. I did ask an account friend, he could not help me! In your explaination I think I’m getting hung up on amount the “you paid”. I’m taking you up on your offer to post the numbers. Sorry I’m being so dense!</p>

<p>The total bill from college in 2010 for tuition,fees,room and board was $33961.98 and this same amount was the gross distribution from 529 with $424.44 of it earnings list on the 1099Q.This amount was paid directly to college. “We paid” and additional $624.77 for books on our cc. There was no computer or deposit, that was in 2009 when D was a freshman.</p>

<p>Thank you again. You, Swimcatsmom and Vballmom are a terrific contributors to CC.</p>

<p>Income more than $160,00 less than $180,000. I am also trying to do this on a tax software program, which I think is contributing to my confusion.</p>