529 Distribution for child who graduated in 2018 on full ride

[krk3384]

My daughter graduated in 2018 and had a full ride scholarship. The college money saved for her is still in a 529. Can I do a 529 non-qualified distribution to her in 2020 without the 10% penalty on earnings? She is no longer a student. If so, how do you indicate that the 10% penalty does not apply in Turbo Tax / Tax forms?

[Hal_Al · Accepted solution]

You will be subject to the 10% penalty.  In order to avoid the penalty (use the scholarship exception), you had to do the withdrawal in the same year that the scholarships paid her expenses

[NCperson]

what 'scholarship exception'?  can you please direct me to that publication?

example: 

1099-T - Box 1 = $10,000; Box 5 = $10,000 (the tuition was covered by the scholarship)

1098-Q - box 1 = $5000; box 2 = $1000

further assume $5000 of room and board expenses 

$500 of the earning is taxable (because only half of the distribution was required to cover the Room and Board), and subject to the 10% penalty, right?

[Carl]

Since your daughter has graduated in 2018 already, there is no "exception" for you for 2019 or beyond. So no need to waste to your time really. Bottom line is, there will be a 10% penalty on withdrawals not used for education. Period. But there are some options you are probably not aware of.

 - If you have someone else in the family that is attending college in 2019 or beyond (assuming you are the custodian of the 529 account) then simply change the beneficiary of the account and they can use the funds for their qualified education expenses.

 - If your daughter will be going for a master's degree later, just leave the funds there and change nothing. She can use them for qualified expenses for the master's degree.

[krk3384]

Ok. I have a son who is a college senior ready to start his last semester. He also has a full scholarship and therefore has not touched his 529 money. I therefore want to withdraw from the 529 to be disbursed to him to the extent that his $20K scholarship for this semester allows. As this is unearned income I think I should no longer claim him as a dependent. Is that correct? I believe the unearned income may come back to me if I claim him as a dependent. He has a job when he graduates in May and will be working 7 months this year and should be in 12% marginal tax rate. 

[Hal_Al]

Q. I think I should no longer claim him as a dependent. Is that correct?

A. No. Since  you are the "owner" of the plan, not him, the support is considered to come from you (it's your money, not his). Actually, the answer is only probably no."The IRS has not given guidance on how distributions from Sec. 529 plans affect the support tests." Source: http://www.journalofaccountancy.com/issues/2012/mar/20114558.html

Q. I believe the unearned income may come back to me if I claim him as a dependent.

A. No. The  unearned income will come back you, for tax purposes, if the distribution is sent to you.  You have the option of having the plan administrator sent the money to either you or him*.  So, if you want him to report the income, instruct the administrator to send the money to him.  But, see the comment at the referenced link, where they suggest sending the money to you might strengthen your ability to claim him as a dependent.

* For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q. 
The 1099-Q gets reported on the recipient's return. The recipient's name & SS# will be on the 1099-Q.

[NCperson]

@krk3384 - please read the last point of @Hal_Al's post closely! who has to report the 1099-Q is often misunderstood! - whomever receives the money is who reports the 1099-Q - not who owns the 529.  the recipient's SS# will be on the 1099-Q. 

from @Hal_Al : 

* For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q. 
The 1099-Q gets reported on the recipient's return. The recipient's name & SS# will be on the 1099-Q.

so one strategy is to make sure the distribution from the 1099-Q is paid directly to the school as your son is probably in a lower tax bracket than you.  Only the 'earning' on the 1099-Q (Box 2) is potentially taxable.  Remember the room and board are good expenses to be paid by the 529 as they are not qualified expenses on the 1099-T.  

and I think it was mentioned somewhere on this thread, you could always maintain the money for grad school ...... or future grandchildren......