529 plan distributions, taxes, and the 1099-Q

Question

Our oldest kid started college this fall. We have a 529 plan with her as the beneficiary. We took $9400 out of the account this fall to pay for her tuition.

There isn't anything to tax because the qualified expenses (shown on a 1098-T from the college) are far more than $9400. When we took the money out of the 529 plan, rather than having the money disbursed straight from the 529 plan to the college, we had the funds sent to our bank account, and then we paid the tuition from there.

We got a 1099-Q from the plan showing a gross distribution of $9400 in box 1. But box 6 of the 1099 is also checked, showing that the recipient of the distribution (me) is not the designated beneficiary (my daughter).

I am filling out 2017 taxes, and I just read that what I did wasn’t the best idea: the IRS computers are apt to send out deficiency notices assessing tax, interest, and penalty, even when you know with certainty that the withdrawals were tax-free based on your beneficiary’s qualifying college expenses.

So is there anything I can do when filling out taxes that shows the distribution should not be taxed? Is there somewhere to report the 1099-Q distribution amount and show it’s less than the qualifying expenses?

Answer 1

I understand your concerns. This is my sixth tax year with education expenses. The 1098-T, the 1099-Q can be very confusing. There is a twist with form 1098-T: Many (most) schools also report the spring tuition on the same form.

Yes it is easier if the money goes right from the 529 to the school. But it doesn't change the fact that those funds were for qualified expenses.

Because my kids 529 plans haven't covered all their qualified expenses I have also needed to file form 8863 for the American Opportunity Credit.

I have found that when completing my tax return with Turbotax I have used the Q&A format to enter the numbers for the 1098-T and 1099-Q, and then opened the relevant forms in form mode. I believe that there is a worksheet associated with the 1098-T that allows you to specify how much was for the spring semester and how much for the fall semester. Then the second year the numbers from the previous years worksheet are ported over.

When the second kid starts college there is another confusing aspect. The 529 withdrawals are combined onto one 1099-Q for the parent. If the money goes straight to the school they will send two 1099-Qs; one for each dependent. For the combined 1099-Q the solution is to split the form as if they were two forms. It is easy to know how much was for each dependent, it is harder to know how to split the interest portion.

Answer 2

You didn't cite the source of the warning, but I don't believe it's correct.

As long as the numbers add up, i.e. the 1098-T justifies the withdrawal, you have nothing to worry about. I'd worry if the withdrawal was used for otherwise legit items, such as books, computer, etc, which don't flow to the 1098, and might otherwise trigger a request for you to justify the numbers. I'd go so far as to suggest that it's far more common for the parent to be the only one in the "follow the money" flow of cash. My daughter's college sends us the bill, on line, and I arrange for the payment, a direct ACH transfer. No money hits any account in her name.

While I am confident of this answer, and very careful with a paper trail, I'll disclose that this tax return, filing for tax year 2017 is my first with college expenses. If I get an IRS notice, I'll edit. Between the numbers adding up, i.e. the expense being far higher than the 529 (or Coverdell account) withdrawal, the IRS has nothing to gain by going after this. Again, I'd be very curious to read the article that triggered this.