I’ve read a ton about 529s and who to get funds distributed to, how to report it on your 1040. But I’m still confused. Here’s my plan:
• Funds will go directly to the college (not to me nor to my son/the beneficiary) in the same calendar year as the tuition bill.
• Because we won’t be getting financial aid, I don’t think I need to worry about the funds being distributed directly to the university. All of the articles I’ve read about why this is not a great option have to do with the school seeing the funds as a way to reduce financial aid. In my view, the funds going directly from the 529 to the school = no middle man.
• I’ve also heard there are less questions by the IRS when the funds go directly to the school, presumably because the school wouldn’t be billing for something that wasn’t a QHEE. Although I have no idea is this is true or not.
• My main questions are: If the 529 funds go to the school directly, whose social security # is on the 1099Q you receive? And whose tax return does anything get reported on – us or our son? (Although I’ve also read you don’t actually report anything as long as all funds are for QHEE – which they will be.)
I’ve seen a few threads on here where parents heard from the IRS assessing taxes and penalties on unreported distributions – and they spent hours getting that “fixed.” I don’t want to go through that, obviously. I am hoping distribution to the school directly will “match” the 1099Q (reported on behalf of my son?) with the 1098-T (which goes to my son? – right)? And with a match, the likelihood of any flagging or proof needed goes down.
We have a CPA and a financial planner, and neither of them could actually answer these questions. In fact, the financial planner said to just have the funds distributed to us (the owners) because then we had more flexibility with how the funds are used for QHEEs. For example, for things like books or supplies that don’t get directly billed by the school. However, I’ve heard that’s the worst option – to have it distributed to the parent – because if there is ever any dispute or non-qualifying expenses or taxes owed on earnings, etc., it would be at the parental tax rate instead of the student’s.
Does any of this make sense? It’s making my head spin. It’s pretty crazy how confusing this is. Any advice or help from those who’ve figured this out would be greatly appreciated!
I would also love to know the best option. I was thinking of taking the entire amount out in one year and paying what I could on child 1 and 2 for the fall. No one can tell me which way would be better tax wise as well as financial aid wise.
All of the articles I’ve read say to have the funds distributed to your child. That way, if there is anything that’s taxable, it’s at THEIR rate, not yours. What I can’t find is an answer to WHO reports any taxable earnings or whatever if the funds go directly to the college: parent or student? Although, again, I don’t anticipate anything being withdrawn that exceeds QHEE.
I should’ve researched your question myself before I started using our 529! First semester, I waited too long and the only option was to transfer the funds to my checking and pay the school. For 2nd semester I added my son’s school and they were paid directly. I got a notice that that payment would be reported under my son’s SS#. I haven’t figured out the implications yet! But I didn’t take out more than we were billed so it should be fine
Do distributions to a parent or child/student then count as “income” for that year on the FAFSA? As opposed to asset when the funds are still in the 529? If income, then wouldn’t distribution to parent be better? We haven’t started this process yet but want to be ready.
Interesting question about the effect on FAFSA. I suppose the only way to avoid that is to not have any taxable earnings to report if you use every dime in your 529 for qualified expenses.
My understanding is if the account is owned by the parent or student, distributions are not counted on the FAFSA (assuming you don’t take out more than college expenses are). If the account is in a grandparents name, the distribution counts as income for the student.
I’ve been doing this for over 1 year and have had some experiences. Everything is amazingly hidden from the IRS. There us no way to report to the IRS to vouch for your legitimate spending. My brush with IRS was when I did an indirect rollover from one 529 to another before my D was in college. The plan paid me, the account owner, directly. There was no way to report this rollover on my tax return. Two years later I got a letter demanding taxes on the withdrawal. I showed them the paperwork, case closed. So from now on, I have my D do the withdrawals, and then I take the money back right away to pay myself back or hold for a future payment. I figure the payments to my D will draw less scrutiny for auditing. The only way the IRS can catch somebody is to audit you, and the way they audit you is to demand taxes. Therefore, I keep careful records on withdrawals and match them carefully to the payments that they are being applied to (either past or future but must be same year as withdrawal); the withdrawals are made in exact dollars and cents to match up to the bills that are being paid. College doesn’t need to know and has no business knowing that the money comes from a 529. As far as I can recall, FAFSA asks nothing about 529 money.
You need the 529 distributions and the payments to the school to happen in the same tax year, so be careful when this happens at the end of a year.
When the middle man is you or your son, it’s really not that big of a factor. My strategy has been to have the distributions go to my daughter via ACH/direct deposit transactions to a joint checking account that she and I both have, for reasons you’ve read about in the articles and also because I want my daughter to write the checks to the school, so that she can have a solid understanding of how much her education is costing.
Not true in many circumstances, because schools can and will definitely bill for many different things that are not QEE. Think health fees, library fines, car parking permits, dorm damage fees, etc.
In this case, the student’s SSN would be on the 1099-Q. If all or part of a distribution paid directly to the school was not qualified, the tax reporting would be done on the student’s tax return.
There most likely will not be a direct match between the 1098-T and the 1099-Q, because the school never includes expenses on the 1098-T that are QEE and that probably will be paid for with 529 funds and therefore will be included on the 1099-Q. This is primarily room and board, and books and other required class supplies. It also includes a computer used for school and associated hardware and software.
A payment made to the parent that turns out to be completely or in part taxable would be reported on the parent’s tax return. A payment made to the student or the school that turns out to be completely or in part taxable would be reported on the student’s tax return.
Thank you so much! This is so helpful. Just the info I was looking for. Your idea of disbursing to your child through ACH/direct deposit is a great one. As is understanding the costs of things. Great idea. I do know about making sure you withdraw funds in the same calendar year that you pay a bill. For one of the schools my son is seriously considering, the bill for spring semester is DUE on Jan 5. That means I’d need to withdraw funds on January 2 (closed on New Year’s, I imagine) and then FED EX the check to the school by 1/5. If I instead have a direct deposit/ACH done on 1/2 into my son’s checking account, then my son could theoretically handwrite his own check and deliver it to the bursar at the school himself. Or, potentially set up online banking and pay the school electronically through his account. BTW, for this particular school, we’ll be using the 529 funds for room and board primarily. We’ll be paying for books and fees outside of the 529.
Not if the distribution is coming from a 529 owned by the student or a custodial parent, as long as the distribution is used for QEE. The earnings portion of a non-qualified distribution would show up as income, because it would be included on either the student or parent tax form (depending on who the distribution was paid to) in AGI.
I have only had the withdrawals coming to me (the parent). I did get a letter from the IRS one year telling me I owed taxes on the withdrawal. I faxed them the supporting documentation and that was it. It really wasn’t such a big deal (although maybe at the time it did bother me). I have never heard that withdrawals to the school could affect financial aid, but, as I said, I have never made withdrawals that way. Not sure how anyone would really know.
We have this same “problem.” I want the 529 distributions and payments to match up with the calendar year of the semester that is being paid for. This year, the spring semester expenses were billed in early December and were “due” on January 2. (The real college due date, payment after which incurs a late fee of $100, is actually the first day of classes for the semester, which for spring semester is the third week of January, but the invoice statement asks for the money earlier.) I made a phone call to the 529 administrator on January 2 to request the distribution, the money showed up in the checking account two days later, and my daughter wrote and mailed the check the day after that. The folks in the school business office understand how 529 accounts work in light of IRS regulations, so at least in my daughter’s case there hasn’t been any problem in paying the spring expenses a week or so after the artificial due date.
With all the piles of paperwork coming through a school’s business office, it’s been reported that sometimes a school will misidentify a 529 payment as an outside scholarship received by the student. For a student getting need-based aid from the school, this mistake would probably lead to a dollar-for-dollar reduction in the school’s aid.
From a 529 perspective it’s fine (as long as the 529 distribution and credit card payment happen in the same calendar year), but many schools will not accept a credit card for payment, or if they do, they may add a surcharge.
OK, to clarify, a grandparent’s 529 can be distributed directly to the student, who then uses that money to pay part of the tuition bill (either via debit card or check), then there are no tax consequences for anyone, correct? Student doesn’t report that as income as long as it’s used for tuition?
All correct, with a caveat: there would be no income reporting on tax forms, but the 529 money from a grandparent would need to be reported as untaxed income on future FAFSA and Profile filings.