By Theresa Cagle Fry, Senior Vice President and Manager IRAs, Retirement & Education Planning
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Saving through a 529 education savings plan has several income tax benefits. Although you can’t deduct the contributions you make to a 529 plan from your federal income tax return, your contributions may qualify for a state income tax deduction or credit. In addition, your investment earnings are tax deferred. When you use a 529 savings plan to pay for qualified education expenses, the payments from the 529 plan are income tax free.
If you took a 529 savings plan withdrawal last year, you will receive IRS Form 1099-Q. It reports all the payments that have been made from the 529 savings plan, regardless of how they were spent. When you receive a 1099-Q, what do you do with it?
For Qualified Education Expenses, Keep the 1099-Q With Your Tax Records
Qualified education expenses for attending colleges or universities generally fall into four categories:
- Tuition and fees
- Housing and food
- Books and supplies
- Equipment that is required for enrollment or attendance, such as computer equipment or internet access
If your withdrawals did not exceed your qualified expenses for the year, the 529 plan distributions are income tax free. If this is the case, the 1099-Q can just be kept with your other important tax documents.
Other education expenses that are considered qualified for federal income tax purposes when paid for with a 529 plan withdrawal include K-12 tuition ($10,000 maximum per year), student loan repayments for the 529 plan beneficiary (student) or siblings of the beneficiary ($10,000 lifetime limit per beneficiary), or certain expenses for registered apprenticeship programs.[i]
Also, remember to reduce your expenses by the amount of any tax-free grants or scholarships the student received.
For Non-Qualified Withdrawals, File the 1099-Q With Your Income Tax Return
Non-qualified distributions can occur if you withdraw more from the 529 savings plan than you had in qualified expenses or if you use 529 withdrawals for non-qualified expenses. Transportation costs, fees for extracurricular activities, health insurance, or other expenses that are not required for enrollment or attendance are a few examples of non-qualified expenses.
If you received a non-qualified distribution, the earnings that are reported on the 1099-Q must be included in taxable income on your federal income tax return. In addition, a 10% penalty will apply on the earnings.
Keep in mind that if the 529 savings plan paid the distribution to the student, directly to the school or the student loan provider, the student will receive the 1099-Q. If the 529 plan paid the distribution to the account owner, the account owner will receive the 1099-Q.
The educational institution will also issue a Form 1098-T to report the tuition and fees paid for attending the college or university. This can sometimes cause confusion because Form 1098-T doesn’t reflect all expenses that may be qualified for 529 savings plan withdrawals. It does not include housing and food or other uses of the 529 plan such as, K-12 tuition or student loan repayments.
If you received a Form 1099-Q, talk to your tax professional about the appropriate records you should keep showing the qualified education expenses you paid. For additional information about 529 education savings plans, contact your financial advisor.
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[i] State income tax treatment may vary from federal income tax treatment. Consult your tax professional for additional information for your personal circumstances.
IMPORTANT DISCLOSURES: The information provided is based on internal and external sources that are considered reliable; however, the accuracy of this information is not guaranteed. This piece is intended to provide accurate information regarding the subject matter discussed. It is made available with the understanding that Benjamin F. Edwards is not engaged in rendering legal, accounting or tax preparation services. Specific questions on taxes or legal matters as they relate to your individual situation should be directed to your tax or legal professional.