529 Withdraw Based on Employer Tuition Reimbursment/Scholarship

[ancATL]

Hello.  I have a question regarding my 529.  My employer has offered to pay for my full part-time law school tuition at my local state university.  The total will amount to roughly $15,000 dollars a year.  If I understand correctly, I'm assuming I will be able to avoid the 10% penalty if I take out from my 529 the dollar amount equivalent (e.g., $15,000) of the reimbursement as a scholarship.  I understand that i will still have to pay income tax on the earnings portion of the $15,000 dollar distribution as it is not a qualified expense, but I wanted to confirm if I would avoid the 10% penalty.

Also, a second question.  I understand that I have to pay taxes on any tuition reimbursement after the initial $5,250 provided by my employer (e.g., I pay taxes on the remaining $9,750).  Do I report only the money after the initial $5,250 (e.g., $9,750) or do I report all $15,000?

Thank you very much in advance!

[KrisD15]

I would caution that the IRS would not categorize Employer Reimbursement as a Scholarship. 

I base this reasoning on the fact that the employer gets a tax break by claiming this as an expense, and you are not being taxed on those funds. 

According to the IRS:

“To determine if total distributions for the year are more or less than the amount of qualified education expenses, you must compare the total of all QTP distributions for the tax year to the AQEE. Adjusted qualified education expenses (AQEE). This amount is the total qualified education expenses reduced by any tax-free educational assistance. Tax-free educational assistance includes: 

• The tax-free part of scholarships and fellowship grants (see Tax-Free Scholarships and Fellowship Grants in chapter 1); 

• Veterans' educational assistance (see Veterans' Benefits in chapter 1); 

• The tax-free part of Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chapter 1); 

• Employer-provided educational assistance (see chapter 10); and

• Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.”

I would NOT use the Employer Tuition Reimbursement as an excuse to by-pass the tax on the distribution.

HOWEVER-

If the employer pays tuition reimbursement, only 5,250 will be tax-free. The remaining 9,750 will be included in Box 1 of your W-2, and you will pay tax on that income, therefore expenses over the 5,250 may be claimed by you to apply towards an Education credit or distribution. 

Most 529 plans can be used for Room and Board expense while attending school, and that does not need to be "in school assigned housing", it only needs to be at or below what the school charges. If you pay for food and rent, that might compensate for the excess distribution. 

FYI- Secure 2.0 is changing the rules on 529 Plans and unused funds may be rolled into a Roth IRA for the beneficiary. 

 Your W-2 should do the reporting for you as far as listing the 5,250 tax-free, and the remaining 9,750 in Box 1. If the program does not pick up the 5.250, you would enter that as "Employer Assistance" in the Education section. 

[Hal_Al]

I agree with @KrisD15 , Employer Tuition Reimbursement does not count as scholarship for the 529 penalty exception. 

I also agree that  since $9,750 of the reimbursement was included in your taxable income, it's not really reimbursement for the purpose of the tax rules. Only the first $5250 is TAX FREE reimbursement.

So, you can take out $9750 from your 529 plan, not only penalty free, but tax free too (no tax on the earnings).  And as KrisD15 said, you can take out room and board (with some limits), if you are a half time or more student