529 Plans – A Precautionary Tale

Posted on Thu, Sep 01, 2016 ©2021 Drucker & Scaccetti

IMG_0405.jpgBy: Steve Rossman, CPA, MT

 

With Labor Day almost upon us, kids (and grown-ups) are focused on back to school festivities.  As we discussed in a recent blog, 529 Plans are a powerful tool for funding higher education costs, which allows your contributions to grow tax-free for future qualified use.  Along with the many benefits of 529 Plans, you should also be aware of some reporting requirements, specifically when a parent or student is reimbursed directly from the 529 Plan.

 

When distributions are taken from a 529 Plan to reimburse higher education costs, the Plan will issue IRS Form 1099-Q.  As long as all of the reimbursement is used for qualified costs, there is no taxable income to the recipient.  The issue is how to tell the IRS these funds were used for higher education or “qualified” purposes.  For most other IRS forms, there is a specific place to report the income and associated expenses.  For example, distributions from a Health Savings Account and associated medical expenses paid by the taxpayer are reported on Form 8889.  Unfortunately, there is no similar form for reporting reimbursements from a 529 Plan.

 

If you do not disclose that reimbursements from a 529 Plan were used for qualified expenses you may receive an IRS Notice CP-2000. While you can easily resolve this notice by sending the IRS proof that the reimbursements listed on the 1099-Q were used for qualified expenses, you can take steps to reduce the chance of receiving an IRS notice related to Form 1099-Q.  Here are a few  suggestions:

 

  1. If you received a 529 Plan distribution, be on the lookout for Form 1099-Q and be sure to provide it to your tax preparer.
  2. Request a letter from the 529 Plan that details all of the expenses reimbursed to you for the tax year. Also, keep receipts for all qualified expenses you incur.
  3. Attach the letter from the 529 Plan to your tax return. Alternatively, some tax software programs have a student expense worksheet that can be used to report reimbursed college costs.

 

As students head back to school, they should focus on their studies, and not worry about receiving correspondence from the IRS.  Taking a few precautionary steps can reduce the likelihood of an IRS notice.  If you have questions about education expenses or any other tax topics, The Tax Warriors® at Drucker & Scaccetti are here to help.

Topics: IRS Notice, 529 Plans, Distributions

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