Handling transfers between ESA and 529 - 1099Q

[ofg007]

I transferred the entire balance from my son's ESA account to his 529 account. Both with Vanguard. On the 1099-Q for the ESA account, Vanguard coded box 6 (Distribution code) as 1 which applies for distributions including transfers. I never got hold of the funds as it was done by Vanguard. Vanguard also left box 4 empty as it did not consider this as a trustee-to-trustee transfer (as for ESA, Vanguard is a brokerage fir, not a trustee).

Do I need to inform the IRS that this was a transfer and not a withdrawal? If yes, how? Do I attach a note? or use form 8275 'Disclosure Statement'

[MarilynG1]

In the 1099-Q section, you can report the distribution as 'Rolled over into another qualified plan'.  If you're using TurboTax Desktop, you will see this on the Payments from Qualified Education Plans worksheet in FORMS.  No amount of the distribution will be shown as taxable in this case. 

Type '1099-Q' in the Search area, then click on 'Jump to 1099-q' to get there.

However, you are not required to enter the fund transfer reported on Form 1099-Q in a non-taxable situation.  Keep it for your records, along with documentation of the rollover, in case the IRS questions the distribution with no Education Expenses on your return.

Here's more info on Form 1099-Q. 

@ofg007 

[Hal_Al]

@MarilynG1  said "However, you are not required to enter the fund transfer reported on Form 1099-Q in a non-taxable situation"

That's good advice.  Don't bother to try to enter the 1099-Q, in TurboTax. You just risk making an error.  When none of the 1099-Q is taxable, TurboTax will enter nothing about the 1099-Q on the actual tax forms. Nothing is sent to the IRS about your 1099-Q. 

Reference: On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 

[ofg007]

Many thanks @MarilynG1 and @Hal_Al for your prompt responses.

Update - I managed to navigate TT and was able to enter a rollover of a portion of my 529 distribution back to another 529 account. Note this is a different rollover than the one mentioned in my original post. After the rollover, I had a very small amount left over as excess distribution which I reported and as @MarilynG1  mentioned in the post, TT accounted for all of this in the Payments from Qualified Education Plans worksheet in FORMS. It worked flawlessly. I followed advice elsewhere in the forum to enter the 1099-Q for my son's 529 (listing me as the recipient) info first, then enter the 1098-T.

However, when I tried to enter the 1099-Q for my son's ESA where he is listed as the recipient, TT told me I do not have to enter such info as I am not the recipient. It is this one that I am concerned about as the amount is relatively large, and it is coded as '1' (applies to distribution and transfers) while it is a direct transfer from my son's ESA to his 529. Neither one of us had a hold of the funds. It was all done internally. Any thoughts regarding the following options:

1- Put a blank sheet with a note that to clarify that that "1" is for a transfer not a distribution. This will entail printing my TT tax forms sending by mail with the attached note.

2- Use form 8275 Disclosure statement. I am not sure if this even applies in this situation.

3- Not attach a note, and file electronically. I have all the documentation for the transfer should the IRS have any questions.

Any insights are much appreciated. Thank you. 

[Hal_Al]

@ofg007  said "However, when I tried to enter the 1099-Q for my son's ESA where he is listed as the recipient, TT told me I do not have to enter such info as I am not the recipient"

You cannot enter a 1099-Q, on your return, if somebody else was the recipient. In this case, it goes on his tax return, if you are even going to enter it. 

[ofg007]

@Hal_Al my son does not have a tax return. He is on my tax return as a dependent. He is listed as a recipient on the 1099-Q. Neither one of us received the funds as it was directly rolled over to his 529 plan. Would it be worth it to attach a note as per my earlier message to clarify to the IRS?

[Hal_Al]

Q. Would it be worth it to attach a note as per my earlier message to clarify to the IRS?

A. No.

Since you are not the recipient, the IRS is not looking for it to be reported on your tax return. 

Just because he is your dependent, does not mean that he does not have to file a tax return. A dependent's income cannot go on the parent's tax return*. If he has enough income, including a taxable portion of an ESA (or 529) distribution, he has to file a tax return of his own.

But, since this was a direct transfer/rollover, none of it is taxable and it does not have to be reported, at all. If you tried to prepare a tax return for him, you would end up with a form 1040 with all blanks (assuming he has no other income).  It can't be e-filed and mailing it in would raise a bigger red flag than doing nothing.  TurboTax will enter nothing about the 1099-Q on the actual tax forms. Nothing is sent to the IRS about his 1099-Q, when it's not taxable. 

*There are some minor exceptions, but this isn't one of them. 

[ofg007]

Many thanks @Hal_Al . This is very helpful.

Indeed, he has no income and thus does not file.