Over Contributed to Coverdell in 2019 and 2020

[MNYL]

Hi Experts,

I read a similar post that I would need to file the Form 5329 (with 6% penalty fee) for each of my 2 beneficiaries (under 18) on their separate Coverdell accounts since I just realized tax year 2019 & 2020 I over contributed to their accounts. I am also not qualified to contribute for 2021. Pls. kindly advise questions below:

1. I will remove the over contribution. But the distribution that I take out, would those need to pay the 10% penalty as well?
2. If I want to open a new 529 accounts and put in the distributions taken out, would this consider as rollover and won't incur the 10% penalty fee? I can ask if the brokerage company can mail the distribution check or e-transfer directly to the new 529 account to avoid sending back to me for penalty fees?
3. If there's no way to avoid penalty fees, can the distribution be used for the private school tuition as it will qualify to be the education expense?
4. Since both children's account need to remove the excess contribution, can I use child A's distribution (without paying extra fees) for child B's tuition cost since B is on private school?
5. In 2023, I will receive the 1099R or 1099Q for both 2019 and 2020 tax year, both can just be reported on 2022 tax return? I will remove the over contribution and will have the brokerage company calculate the earnings on the contribution and withhold taxes from the distribution (best way to do?).
6. Per Pub 970, the beneficiaries are responsible for excess contribution and they don't file tax return on their own, so I just file Form 5329 will be sufficient? There won't be a need for me to amend my tax return for 2019 and 2020? If no, any way to avoid?
7. I would need to file year 2019 and 2020 Form 5329 for both children. Form 5329 should still file with my name and SSN# and file Part V (mainly line 28, 31 and 33)?
8. Please advise the best way to handle this situation to avoid paying more penalty fee or taxes.

Thank you so much!!

[MNYL]

Can the experts provide some insights here please? Thank you!

[RobertB4444]

1.  You are going to take the overcontribution and earnings out.  The 6% penalty is assessed on this total amount, yes.

2. You can absolutely open a new coverdell account and put the amount in that you have pulled out of the other two.  But remember - the limitations are per beneficiary as well so you can't open an account for one of your children that you have already maxxed out contributions for.

3. Yes, any qualified education expense would qualify to remove the penalty as long as it is for the named beneficiary of the account.  

Qualified educational expenses are for elementary and secondary educational institutions, kindergarten through grade 12, and postsecondary educational institutions, such as colleges or universities, that participate in the student aid programs administered by the US Department of Education. The institution can be public, private, or religious. Qualifying expenses, if they are incurred because of enrollment or attendance at the institution, include:

• tuition and fees,
• books, supplies, and equipment,
• academic tutoring, and
• services provided for a beneficiary with special needs.

However, the following expenses are qualified only if they are required by the educational institution:

• room and board,
• uniforms,
• transportation, and
• other supplementary items and services, including extended day programs.

That all comes from here.

4. No.  The account has a named beneficiary.

5. Yes, you can just enter it all in the year that you receive the 1099.

6. Just form 5329 by itself is fine - unless the overcontributions are used to pay qualified education expenses in which case there is no reporting requirement at all.

7. Yes.

8.  Pay educational expenses with the overcontribution and earnings.

[MNYL]

Hi RobertB4444,

Thank you so much for your reply!!   Kindly see below for some clarifications:

1.  The over contribution and earnings I take out, these won't be considered as early distribution (10% penalty)?

2.  Over contribution + earnings would be what I need to report on 5329 (not just the excess portion), correct?

3. If I get the money distribute to me (e.g. check or electronic transfer to my account), how do I report the money was used for education expense to avoid the 6% excess fees?

4. When I withdraw the over contribution and earnings, I will withhold the federal and state taxes, so I won't need to worry about amending any tax return, correct?  Would my 2021 tax return need to report the distribution (over contribution and earnings) in advance?

5. So if I file Form 5329, can I put both children's over contribution onto one form (e.g. excess $2000 on each, would report $4000 (+ earnings))?  Or I will do each separately for both year 2019 and 2020 (total 4 forms to send)?

Really appreciate for your assistance!!

[MNYL]

Forgot to mention for #2 below, I was referring to the rollover to a new 529 plan not a new Coverdell.  529 should not have income restriction.  Just not sure if rolling over the over contribution plus earnings can avoid the 6% excess fees.  But 529 plan people said for rollover, they will need to initiate the rollover from my current Coverdell accounts, not to have my current brokerage to send directly to them.  This would be tough as not knowing the exact amount yet due to brokerage will need to calculate earnings once I submit the removal of excess form.  

Any insights here?

[MNYL]

Anyone has any insights, please kindly reply.  Thank you!!

[RobertB4444]

1. The 1099-Q that you receive for pulling out the excess contributions should be coded '2' or '3' which just means that you are pulling out excess contributions and earnings.  The earnings should appear in box 2a as the taxable amount.  The taxable amount should be subject to a 10% penalty.

2. Correct.

3. If it is used for qualified educational purposes it doesn't have to be reported at all.  Save the receipt and if you are questioned over the distribution provide receipts showing how the money was spent.

4. When you pull the money out the overcontribution and withdrawal should hopefully be coded '2' which says it is to be reported in the current year, not the prior year.  

5. Match your 5329 forms to the 1099-Qs that you receive.  If you get four forms respond with four forms.  The IRS likes things that match.

Bonus question - 529 plans don't have contribution limits like Coverdell plans do.  However, deposits put into them do count as gifts and the gift exclusion is $15,000 ($30,000 for a married couple) so that is the effective limit.  So putting your overcontribution into a 529 instead of a Coverdell is a fine plan.  Not as good as spending it on education expenses which eliminates the need to worry about any of this, but still a fine plan.

[MNYL]

Thank you so much RobertB4444!   So I will remove the over contribution and earnings from 2019 and 2020 and these can just send back to my bank account.  These excess I will use for one child for the private school tuition (all come from this year 2022 not prior years) so I do NOT need to fill the form 5329 or worry about paying any penalty or early distribution fees.   The other child I will need to fill the Form 5329 for both 2019 & 2020 and pay the fees.  Tax return 2021 I don't need to report anything, just wait until 2022 when I receive the 1099Q.  All these are correct?

Many thanks for your prompt assistance!!

[RobertB4444]

@MNYL  You've got it!