Do you think your accountants are under the impression that the earnings portion of a qualified 529 distribution is tax-deferred and not tax-free?
Ok …The answer I got "Yes, you do have to report 529 withdrawals (they are reported on form 1099-Q) to show to the IRS that the amount is nontaxable because you spend it for qualified education expenses. Qualified education expenses for the purposes of the 529 plan distributions includes room and board, books tuition and fees Scholarships/grants are applied to qualified education expenses ONLY. Those qualified expenses are tuition, books and lab fees. That’s it. (though the definition of lab fees is rather broad). After that, any excess scholarship money is taxable income to the student. Grants/scholarships can NOT be used for room and board.
Next, 529 funds reported on the 1099-Q are applied. First to any tuition not covered by scholarships. Then it’s applied to the unqualifed but “allowed” expense of room and board
The allowed expense of room and board was the issue and the type of residence D is staying in.
OK. Here’s a really dumb (but at least straight forward) question. Can we direct the 529 plan to just pay the school directly? Or is the protocol to always withdraw the amount you want into your checking account and then pay?
However, I am told that if I have released directly to university in future this will not be reported to me and I will have no tax liability.
@homerdog, Yes, generally you can you have the 529 pay the school directly. Lots of people do this.
This is not true. Qualified 529 distributions are not reported on the tax return. The 1099-Q is for informational purposes only; there is no IRS requirement that 1099-Q numbers be reported on a tax return in all cases.
This is also not true (generally). Unless a grant or scholarship specifically states that it cannot be used for room and board, or specifically states that it must be used for something that is not room and board (for instance, can only be used for tuition), grants and scholarships can be used for room and board, although the amount used for room and board will be included in the student’s taxable income.
If your accountants are really insisting that a qualified 529 distribution must be reported somewhere on a tax return to show to the IRS that the amount is nontaxable, you need to find new accountants.
@3puppies so why are people taking withdrawals? Maybe most for off campus housing/books?
More falsehoods or half-truths. Having a qualified 529 distribution paid directly to the account owner or the student/beneficiary does not change any of the tax liability issues. It makes no difference to whom the 529 distribution is paid; what matters is what the distribution is used for and the timing of the 529 distribution and the expenses that are being paid.
Perhaps, but 529 owners often take distributions, either payable to them or the student, that are then used to pay qualified expenses that have been directly billed by the school. One reason to do things this way is so that there is no possibility of the school getting confused as to where the money is coming from. There have been instances where a school has mistaken a 529 payment sent directly to the school as a scholarship payment, and the school then reduced need-based aid on the assumption that the student had less need because of a “scholarship” payment made on behalf of the student.
Check the investment pathway in your 529, if it is age based and becomes automatically conservative in FDIC accounts, you should do the math re costs (fund costs) and benefits ( interest, any state tax carrots etc) vs current CD rates in non 529s. Some 529s are more user friendly to adjust investment options, so if you don’t need it to be conservatively protected and can bear the risk, look at more aggressive options if you want to use it later rather than now. The option to change pathway might be limited to twice a year or similar.
Thx @BelknapPoint full pay over here so that won’t happen to us. S19 is our oldest and, depending on where he ends up, we will most likely have 2/3 of his four year tuition in his 529. Just have to figure out if we drain it starting at the beginning or just use a smaller percent and use some income to make up the difference. I’m leaning towards draining it and just using other savings for the last few payments.
@BelknapPoint. This last point is an excellent one about schools getting confused where the money is coming from
We just started using our 529 money so that’s something to look into. Thx!
So is there no disadvantage to withdrawing the money to our account and then paying the school as long as it all happens in the same calendar year?
We were unable to pay the school directly, so we pay the bill from our checking account, then withdraw an identical amount from the 529. We have been told that as long as we can document that the amounts withdrawn are for education related expenses there is no tax liability. We were told we could have also withdrawn an amount to pay for books as long as it was documented but we have not done that. D is now a junior and so far this has worked fine.
It may be less efficient (two transactions instead of one), but for a distribution used to pay or reimburse qualified expenses, it makes no difference from a tax liability perspective.
Note that if all or part of a 529 distribution is non-qualified, it can make a tax difference based on how the distribution is paid. The earnings portion of a non-qualified distribution paid to the student/beneficiary or directly to the school will be taxable income for the student; the earnings portion of a non-qualified distribution paid to the account owner will be taxable income for the account owner.
I agree with @BelknapPoint - some people like to have control, and to be able to avoid any confusion. Some parents have one 529 savings plan that they will use for multiple students. Since some 529 plans require paper distribution request forms sent via regular snail mail, I can understand wanting to know everything is done right.
If you want to direct the 529 Plan to make the payment directly to the school, it wouldn’t hurt to contact the school first, to find out exactly how they want the payment handled. Out of the millions of kids who attend college, and hundreds of thousands who pay at least a part of it with a 529 plans, at schools all over the country, you can imagine that with even very small error rate, mistakes still happen to lots of kids. One example - a friend told me she had requested a payment to the school directly, and instead of $10,000 which was needed, they only sent $1,000 (which it turned out was what she had actually asked for - it was her own mistake) - but it created a bigger hassle because her son was not able to register for the following semester without getting the balance paid. Anyone who has worked in a bursar’s office can understand that problems happen all the time, most of which can be fixed, but they too often seem to rise to the panic level too early. Because, after all, there is a lot of money involved.
Agree 100%. Keep good records. Submitting documentation is not required, but if the IRS comes calling with questions, you want to be able to substantiate the qualified expenses and the corresponding 529 distribution(s).
@BelknapPoint I have a question about non-qualified expenses similar to what you touched on in one of your posts. . My senior is entering a music performance bachelor’s program and we will use 529 funds to buy him a better instrument once he’s enrolled in a school Should we have the amount needed to buy the instrument transferred directly to our son rather than to our own account to minimize taxes/penalties?
Even though it’s technically a “tool” related to his coursework, the cost of the instrument is going to be about the same as a year of tuition at the least expensive school he is considering, so obviously the amount we withdraw will exceed the published COA. I assume it’s a non-qualified expense.
You should crunch the numbers both ways to see which scenario incurs less in tax/penalty. I think it will usually be the beneficiary/student/child who should take the distribution in a case like this, but without knowing the specific tax situation of both parties, a definitive answer can’t be given.
This can be a gray area. Given the type of program involved, it sounds like the instrument is required for enrollment or attendance. Documentation from the school explicitly stating this would be helpful. In the end, it’s your call, and if you treat the instrument as a qualified expense you need to be prepared to defend your position with the IRS. Posing the question to the FA people at the school might garner some useful information.