My son is a freshman and has received approx $4000 in tax-free scholarships, already credited to his college account this fall. I’d like to withdraw some money for him out of his 529 (he’s the beneficiary) via the scholarship exemption. Currently, the earnings portion in his 529 is about 30%. He is not working and has no taxable income other than slight bank interest.
Questions:
(1) If I withdrew, say, $3000 from the 529 paid directly to him this fall, am I correct in assuming that only the 30% gains portion would be taxable for him ($900), and the other 70% ($2100) would be NONTAXABLE gift income (aka family support money)?
(2) If the answer to the above question is “yes”, then am I correct in assuming that he would NOT have to file any 1040 as long as he has no other taxable income? (Because the minimum non-earned income for filing 1040 is $1100 and his only taxable income for the year would be less than that: just $900 of the 529 withdrawal).
If (2) is also yes, then it seems there would be no taxes on his $3000 529 scholarship exemption withdrawal. Am I misunderstanding anything?
quote If I withdrew, say, $3000 from the 529 paid directly to him this fall, am I correct in assuming that only the 30% gains portion would be taxable for him ($900), and the other 70% ($2100) would be NONTAXABLE gift income (aka family support money)?
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Only the earnings portion of the 529 non-qualified distribution, or $900 in your example, would be taxable. The other $2,100 would not be reported. “Gift income” is a misnomer; there is no such thing. Income is received for goods and/or services; a gift is made with the expectation that nothing tangible will be received in return.
quote If the answer to the above question is “yes”, then am I correct in assuming that he would NOT have to file any 1040 as long as he has no other taxable income? (Because the minimum non-earned income for filing 1040 is $1100 and his only taxable income for the year would be less than that: just $900 of the 529 withdrawal).
If (2) is also yes, then it seems there would be no taxes on his $3000 529 scholarship exemption withdrawal. Am I misunderstanding anything?
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Given the scenario you have presented, there would be no federal income tax owed by your son, as long as he has no earned income for the tax year and his unearned income (bank interest, etc.) is $200 or less. HOWEVER, he should still file a federal tax return if he receives a non-qualified 529 distribution, because he will have to account for the fact that he is not paying the 10% additional tax (“penalty”) based on the tax-free scholarship exemption. This requires filing a 1040, Form 5329, and Schedule 2. The 10% additional tax, if applicable, can not be reduced by a deduction, standard or otherwise. He would need to show why he is not paying the $90 tax that would be owed absent an exemption to the 10% additional tax on 529 non-qualified distributions.
Thanks Belknap. I understand this, and it makes sense. If he did NOT file a 1040, then I suppose some 1099-Q or similar report from the university would raise a flag at IRS?
A 1099-Q makes no distinction between qualified and non-qualified distributions, and the university will have no clue that a 529 non-qualified distribution has been made to your son (unless you tell them, and there’s no reason to do that). But, the right thing to do to dot all the i’s and cross all the t’s is to file the return and document what actually happened. A little extra work next tax season might head off a big headache down the road.
One of the great gifts my dad gave me (and all my siblings) was to help us file our tax returns even when we did not have to pay any tax. I was probably the only person in my first job who did not head off to H&R Block, and I’m likely the only one of my friends now does not need a professional even though my finances are way more complicated than they used to be! If your son fills out the forms (and if you are using Turbotax it’s really a snap) you are giving him a gift.
I’ve got acquaintances who grumble about paying over a thousand bucks for someone to fill out forms. And these are not gazillionaires with multiple properties and depreciation and royalties- these are “working Joe’s and Joan’s” who are usually complaining about how broke they are.
No, I don’t cut my own hair (but with Covid I may need to!) but filling out a return is not that hard if you can read!!!
Good points, Belknap and Blossom. I’m picturing myself helping him fill out taxes next year. Like Blossom, I’ve always done it myself. Takes time, but is interesting too.