Got an unwelcome notice from the IRS asking for taxes plus interest on a 529 plan rollover from 2014. I was thinking that I forgot to document the amount and note that it was not taxable, but there is actually no way to document that in a tax return. Apparently, according to Forbes, if the check box has an x for recipient is not beneficiary, some computer kicks in and thinks it is a non-educational withdrawal. I think they might look at “trustee to trustee” box to find direct rollovers. But this was an indirect rollover. So I had to find the document from the new 529 plan showing the exact amount rolled in, hopefully that is sufficient.
So, other than ragging on the IRS, the lesson learned is to document where your withdrawals went, if you want to use 529 money to pay yourself back. This is the way I prefer to take the withdrawals, so I can decide exactly how much of it use after I’ve spent the money, can withdraw on a Market high, etc. Also school doesn’t know money is coming from 529. This is going to get complicated when I retire and we qualify for education tax credits, and have to account for amounts be covered by 529, education tax credits.
I think if you send them the documentation it should be sufficient.
I am surprised you mention withdrawing on a market high. By the time my kids were in college their funds were in fixed income investments. I always kept my records with the tuition bill to document where the money for the expenses was coming from, over 3 kids never had any issues with taking the education credits. My D did get a letter about the year she had her last semester of college/6 months working, but she talked to them and they agreed they were wrong and we had done her taxes correctly. They were questioning her 529 withdrawals and how she (really me) calculated the tax due on the excess withdrawal for scholarships.
My S has been out of college for 2 years so if we are going to get any letters about him it would be soon. He finished in 3 years, so we took the education credit in the fall of his 3 years, and he claimed it for his last semester the year he graduated. He also lived off campus so I am hanging onto my paperwork still.
In my OP, I proposed that I would use 529 withdrawals to pay myself back for educational expenses, rather than paying to school or D. It appears to come at the risk of unwarranted tax bills that one has to respond to. Does anybody have actual experience doing it one way or the other, advantages, disadvantages? I thought the advantage is that it would stay completely off the books of my D’s taxes/income for whatever advantage that might have.
It is off of your D’s income, is it not? But it is on yours, since they cut the check to you. Shouldn’t be a big deal. Just show a copy of the check where you paid the tuition and a copy of the tuition bill.
529 distributions made payable to your daughter, as beneficiary, are not considered income and are not taxable when used for qualifying education expenses, so there’s nothing to “keep off the books.” When the distribution is made payable to the account owner, as opposed to the beneficiary, the IRS seems to (sometimes) take an interest, wanting to make sure that the distribution is actually going to pay for, or reimburse, qualified education expenses. When the distribution is made payable to the beneficiary, or the school, the IRS seems more willing to make the assumption that the funds are paying for QEE.
The situations where I read it is not off the books is if any of the funds are not used for educational expense, where it is usually less taxable for the beneficiary. Won’t apply to me as I will be bled dry after 3 kids.
Right – like I said, if the 529 money is used for the beneficiary’s qualified education expenses, it is not subject to tax. If 529 money is not used for qualified education expenses, the earnings portion of any distribution is subject to tax, and possibly also a 10% penalty. In this case, it will be “less taxable to the beneficiary” if the non-qualified distribution is made payable to the beneficiary, as opposed to the account owner, and the beneficiary is in a lower tax bracket than the account owner. If the beneficiary and the account owner are in the same bracket, than it doesn’t make any difference, tax-wise, who the non-qualified distribution is made payable to; the tax amount will be the same.