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529 withdrawl for scholarships, not in the year awarded

So I know that the common guidance on taking scholarship money out of a 529 plan is to do it in the same year the scholarship was earned; of course if you don't know if your child may go on for an advanced degree, this may not be the best path. It also seems that the IRS guidance on this is silent and that this guidance seems to be coming from best practice from finance/tax experts.  (If there is explicit guidance from the IRS on this please share). However, since I am not a finance or tax expert, only an individual following IRS published tax guidelines, how would I be expected to follow best practice used by paid professionals? Has anyone actually tested this and taken scholarship withdrawls after the fact, and if so, were you audited? Because if I'm audited, wouldn't the IRS have to show me the guideline or rule that I violated? And does one exist? (and yes I know I can test it myself and find out so no need to reply with that). Thanks for any insight.

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1 Reply
Hal_Al
Level 15

529 withdrawl for scholarships, not in the year awarded

That question has come up in this forum before and the conclusion was the same as yours:

1.  the IRS guidance on this is silent. No explicit guidance from the IRS has been found. 

2.   the common-expert  guidance on using the scholarship penalty exception is that the distribution must be in the same year that the scholarship paid qualified expenses.

 

The scholarship exception is only for the 10%  penalty on a non qualified distribution.  The income tax  is still due. 

 

One loop hole available is to have the student  treat the scholarship as taxable income (at his lower rate and maybe even 0%; the kiddie tax may apply) so that the parent can take an untaxed qualified distribution from the 529 plan.

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