1. 529 plan scholarship exception reporting: I have overfunded my daughter's 529 plan since she receives scholarship from college. She starts college this year. We will claim her as our dependent. We have the qualified education withdrawal from her 529 plan sent directly to her bank account to pay for her education expenses. Since we have overfunded her 529 plan, we plan to have non-qualified education withdrawal for the scholarship portion (her scholarship only covers tuition) penalty free from her 529 plan and have that amount sent to the parent bank account. How should I file for tax in this situation? I want to make sure that I understand how to file the tax, penalty free, for the non-qualified withdrawal before I make the withdrawal.
2. ESA rollover: I have also overfunded my son's ESA since the education expenses are lower with in-state tuition. He is graduating next year, so I plan to rollover his ESA to my daughter's. Will there be any tax implication with the rollover?
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Q. I have also overfunded my son's ESA since the education expenses are lower with in-state tuition. He is graduating next year, so I plan to rollover his ESA to my daughter's. Will there be any tax implication with the rollover?
A. No, if you follow the rules carefully. "If both siblings have 529 plans, you might want to consider a rollover. The distribution will be tax-free if the same amount is contributed to the other sibling’s 529 plan within 60 days. The IRS allows one tax-free rollover in a 12-month period.
Another option is to change the beneficiary on the 529 plan account. 529 plans allow the account owner to change the beneficiary to a qualifying family member (sibling qualifies) of the current beneficiary without tax consequences."
Reference: https://www.savingforcollege.com/article/how-to-transfer-529-plan-funds-to-a-sibling
Q. We plan to have non-qualified education withdrawal, from our daughter's 529 for the scholarship portion (her scholarship only covers tuition) penalty free from her 529 plan and have that amount sent to the parent bank account. How should I file for tax in this situation?
A. You claim the earnings portion of the distribution as income on line 8z of Schedule 1. You file form 5329 to claim the penalty exception on lines 5-8 (Part II).
It can get complicated, in TurboTax. I recommend a workaround:
Enter the 1099-Q. When asked who the student is answer: someone else not listed here (lying to TurboTax to get it to do what you want does not constitute lying to the IRS). Enter the student's name when asked. A few screens later, you'll get one simple screen to enter expenses. Press Done at the 1099-Q summary screen, to get there. Also enter the amount of the scholarship in the box "Tax-free assistance". This reports the earnings as taxable and claims the scholarship exception. You do not have to deal with the complicated “Educational expenses and Scholarships” (1098-T) section later. TT will prepare form 5329 to claim the penalty exception.
Q. We have the qualified education withdrawal from our daughter's 529 plan sent directly to her bank account to pay for her education expenses. Will she have to report this on her income tax return?
A. Probably not. But, she will get an IRS form 1099-Q for the distribution.
You can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if she lives at home) to cover the distribution. When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. You also cannot count expenses that were paid by tax free scholarships. You cannot double dip!
References:
General Discussion on Qualified Tuition Plans (QTP 529 Plans) Distributions
It’s complicated.
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.
Even though the 1099-Q is going on the student's return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because he is your dependent.
You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The American Opportunity Credit (AOC or AOTC) is 100% of the first $2000 of tuition and 25% of the next $2000 ($2500 maximum credit). The educational expenses he claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit, that gets him an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. Another special rule allows you to claim the tuition credit regardless of whose money was used to pay the tuition.
In addition, there is another rule that says the 10% penalty is waived if he was unable to cover the 529 plan withdrawal with educational expenses either because he got scholarships or the expenses were used (by him or the parents) to claim the credits. He'll have to pay tax on the earnings, at his lower tax rate (subject to the “kiddie tax”), but not the penalty.
Total qualified expenses (including room & board) less amounts paid by scholarship less amounts used to claim the Tuition credit equals the amount you can use to claim the earnings exclusion on the 1099-Q.
Example:
$10,000 in educational expenses(including room & board which is only qualified for the 1099-Q)
-$3000 paid by tax free scholarship***
-$4000 used to claim the American Opportunity credit
=$3000 Can be used against the 1099-Q (on the recipient’s return)
Box 1 of the 1099-Q is $5000
Box 2 is $2800
3000/5000=60% of the earnings are tax free; 40% are taxable
40% x 2800= $1120
There is $1120 of taxable income (on the recipient’s return)
**Alternatively; you can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip! When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.
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."
***Another alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit. Most people come out better having the scholarship taxable before the 529 earnings. A student, with no other income, can have up to $13,850 of taxable scholarship (in 2023) and still pay no income tax. You cannot use this "loop hole" (of shifting expense allocation from the scholarship to the education credit), if the scholarship is "restricted" to being used for tuition.
Q. So, I thought to make it easier, I should rollover my son's Coverdell ESA account to my daughter's ESA once my son's done with college next year, but I don't know if this will incur any tax or not.
A. Yes that is allowed. No tax will be due and the rollover does not need to be reported. Reference: IRS Pub 970, pages 43-44.
Q. Or should I transfer his Coverdell account to my daughter's 529 plan instead?
A. No. That does not appear to be allowed, directly. But, once the money is in her ESA, it can be rolled over to her 529 plan.
Q. How should we file tax for the a 529 to Roth IRA rollover?
A. You don't report it on your tax forms. It is a tax free distribution. There is nowhere to enter this in TurboTax.
Q. And since we can only rollover $7k each year, it will take 5 years to complete the rollover. Do we then keep that amount in 529 plan and rollover each year?
A. Yes, if that's your plan. If you do a $7000 Roth rollover the first year, you can do something different in the following years. You're not locked in to doing Roth rollovers later.
Q. Will the 529 plan administrator know that this rollover is for the overfunding due to receiving scholarship?
A. No. They don't need to know. There is no special code that goes on the form 1099-Q. That's for you to report to the IRS on form 5329.
Q. Can I rollover my son's Coverdell ESA account to a Roth IRA?
A. No. I cannot find where an ESA is eligible Publication 970 only says that a 529 is eligible for the Roth IRA rollover.
Q. Can we rollover his Coverdell account to his 529 plan and then to a Roth IRA, penalty and income tax free?A. Yes.
Q. The overfunding in my son's account is not due to receiving scholarship or not getting a higher education. It's because he goes to a state university with lower tuition. So can we still rollover his 529 plan to his Roth IRA penalty and income tax free?
A. Yes. There does not have to be any reason why the account got over funded. If you just mis-estimated expenses or put in extra money in "just in case", you still qualify for tax/penalty free rollovers.
Q. Are there any other criteria that we have to meet for penalty and income tax free rollover from his 529 plan to his Roth IRA?
A. Yes, but you appear to know about those*; the $35K and $7K/yr limit. There's also the 5 year and 15 year rules. See: https://www.fidelity.com/learning-center/personal-finance/529-rollover-to-roth#:~:text=Under%20certa...'.)
Q. On form 5329, it stated that additional tax doesn't apply when including distributions from an education account in income because you used the qualified education expenses to figure the American opportunity and lifetime learning credits. What does this mean?
A. Just like having potential 529 expenses covered by scholarships exempts you from the 10% penalty, having used expenses to claim an education credit also exempts you from the penalty on a 529 distribution in the same amount if used to claim the American opportunity or lifetime learning credits.
*Here's an excellent summary of the rules (Google AI):
"Yes, it is possible to roll over funds from a 529 plan to a Roth IRA, but there are several conditions that must be met:
There is no income limit (high income will not disqualify you from making a Roth IRA contribution via a 529 rollover). But there is requirement to have compensation (earned income) in the year you do the rollover.
"Does the beneficiary need a job or have already contributed to the Roth IRA? The beneficiary must have earned income that at least equals the amount to be rolled over. For example, if you’re planning on rolling over $5,000 in 2024, your beneficiary must have earned at least $5,000 for the year."
"What if the beneficiary makes too much to contribute to a Roth? There is no earned income limit for these transfers. Normally, you can’t contribute to a Roth IRA if your modified adjusted gross income in 2024 is more than $161,000 for single filers or $240,000 for those married filing jointly."
So, effectively, using 529 funds to fund a Roth contribution appears to be a loop hole to the income limit, for a very few people.
I'll page Champ @Hal_Al
Q. I have also overfunded my son's ESA since the education expenses are lower with in-state tuition. He is graduating next year, so I plan to rollover his ESA to my daughter's. Will there be any tax implication with the rollover?
A. No, if you follow the rules carefully. "If both siblings have 529 plans, you might want to consider a rollover. The distribution will be tax-free if the same amount is contributed to the other sibling’s 529 plan within 60 days. The IRS allows one tax-free rollover in a 12-month period.
Another option is to change the beneficiary on the 529 plan account. 529 plans allow the account owner to change the beneficiary to a qualifying family member (sibling qualifies) of the current beneficiary without tax consequences."
Reference: https://www.savingforcollege.com/article/how-to-transfer-529-plan-funds-to-a-sibling
Q. We plan to have non-qualified education withdrawal, from our daughter's 529 for the scholarship portion (her scholarship only covers tuition) penalty free from her 529 plan and have that amount sent to the parent bank account. How should I file for tax in this situation?
A. You claim the earnings portion of the distribution as income on line 8z of Schedule 1. You file form 5329 to claim the penalty exception on lines 5-8 (Part II).
It can get complicated, in TurboTax. I recommend a workaround:
Enter the 1099-Q. When asked who the student is answer: someone else not listed here (lying to TurboTax to get it to do what you want does not constitute lying to the IRS). Enter the student's name when asked. A few screens later, you'll get one simple screen to enter expenses. Press Done at the 1099-Q summary screen, to get there. Also enter the amount of the scholarship in the box "Tax-free assistance". This reports the earnings as taxable and claims the scholarship exception. You do not have to deal with the complicated “Educational expenses and Scholarships” (1098-T) section later. TT will prepare form 5329 to claim the penalty exception.
Q. We have the qualified education withdrawal from our daughter's 529 plan sent directly to her bank account to pay for her education expenses. Will she have to report this on her income tax return?
A. Probably not. But, she will get an IRS form 1099-Q for the distribution.
You can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if she lives at home) to cover the distribution. When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. You also cannot count expenses that were paid by tax free scholarships. You cannot double dip!
References:
General Discussion on Qualified Tuition Plans (QTP 529 Plans) Distributions
It’s complicated.
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.
Even though the 1099-Q is going on the student's return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because he is your dependent.
You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The American Opportunity Credit (AOC or AOTC) is 100% of the first $2000 of tuition and 25% of the next $2000 ($2500 maximum credit). The educational expenses he claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit, that gets him an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. Another special rule allows you to claim the tuition credit regardless of whose money was used to pay the tuition.
In addition, there is another rule that says the 10% penalty is waived if he was unable to cover the 529 plan withdrawal with educational expenses either because he got scholarships or the expenses were used (by him or the parents) to claim the credits. He'll have to pay tax on the earnings, at his lower tax rate (subject to the “kiddie tax”), but not the penalty.
Total qualified expenses (including room & board) less amounts paid by scholarship less amounts used to claim the Tuition credit equals the amount you can use to claim the earnings exclusion on the 1099-Q.
Example:
$10,000 in educational expenses(including room & board which is only qualified for the 1099-Q)
-$3000 paid by tax free scholarship***
-$4000 used to claim the American Opportunity credit
=$3000 Can be used against the 1099-Q (on the recipient’s return)
Box 1 of the 1099-Q is $5000
Box 2 is $2800
3000/5000=60% of the earnings are tax free; 40% are taxable
40% x 2800= $1120
There is $1120 of taxable income (on the recipient’s return)
**Alternatively; you can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip! When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.
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."
***Another alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit. Most people come out better having the scholarship taxable before the 529 earnings. A student, with no other income, can have up to $13,850 of taxable scholarship (in 2023) and still pay no income tax. You cannot use this "loop hole" (of shifting expense allocation from the scholarship to the education credit), if the scholarship is "restricted" to being used for tuition.
Hi Hal Al,
Thanks for your response! For question#2, the ESA I overfunded is my son's Coverdell account, not a 529 plan. My son and my daughter both have Coverdell and 529 plan. So, I thought to make it easier, I should rollover my son's Coverdell account to my daughter once my son's done with college next year, but I don't know if this will incur any tax or not. Or should I transfer his Coverdell account to my daughter's 529 plan instead. Which would be the best option tax-wise?
Expanding question #1:
Q1a, I also learned that we can also do a lifetime rollover of $35k to my daughter's Roth IRA, which would be penalty and income tax free (would be a better choice to avoid income tax totally). I was thinking that we can have $35k from 529 plan rollover to her Roth IRA and the rest as a non qualified education expense withdrawal based on scholarship exception reporting. In that case, how should we file tax for the part with the Roth IRA rollover? And since we can only rollover $7k each year, it will take 5 years to complete the rollover. Do we then keep that amount in 529 plan and rollover each year? Will the 529 plan administrator know that this rollover is for the overfunding due to receiving scholarship?
Q1b, About the unused 529 plan rollover to Roth IRA, since the lifetime rollover limit is $35k, instead of rolling over my son's Coverdell account to my daughter's Coverdell or 529 plan, can I rollover his Coverdell account to a Roth IRA, or rollover his Coverdell account to his 529 plan and then to a Roth IRA? Since my son's did not receive any scholarship, and the overfunding is strictly due to a lower tuition from a state university, can he rollover the overfunding amount to a Roth IRA penalty and income tax free?
Thanks again for your help!
Q. So, I thought to make it easier, I should rollover my son's Coverdell ESA account to my daughter's ESA once my son's done with college next year, but I don't know if this will incur any tax or not.
A. Yes that is allowed. No tax will be due and the rollover does not need to be reported. Reference: IRS Pub 970, pages 43-44.
Q. Or should I transfer his Coverdell account to my daughter's 529 plan instead?
A. No. That does not appear to be allowed, directly. But, once the money is in her ESA, it can be rolled over to her 529 plan.
Q. How should we file tax for the a 529 to Roth IRA rollover?
A. You don't report it on your tax forms. It is a tax free distribution. There is nowhere to enter this in TurboTax.
Q. And since we can only rollover $7k each year, it will take 5 years to complete the rollover. Do we then keep that amount in 529 plan and rollover each year?
A. Yes, if that's your plan. If you do a $7000 Roth rollover the first year, you can do something different in the following years. You're not locked in to doing Roth rollovers later.
Q. Will the 529 plan administrator know that this rollover is for the overfunding due to receiving scholarship?
A. No. They don't need to know. There is no special code that goes on the form 1099-Q. That's for you to report to the IRS on form 5329.
Q. Can I rollover my son's Coverdell ESA account to a Roth IRA?
A. No. I cannot find where an ESA is eligible Publication 970 only says that a 529 is eligible for the Roth IRA rollover.
Q. Can we rollover his Coverdell account to his 529 plan and then to a Roth IRA, penalty and income tax free?A. Yes.
Hi Hal-Al,
Thanks for your response. I have two more questions.
1. You mentioned that we can rollover my son's Coverdell account to his 529 plan and then to a Roth IRA, penalty and income tax free. Are there any criteria that we have to meet for penalty and income tax free rollover from his 529 plan to his Roth IRA? The overfunding in my son's account is not due to receiving scholarship or not getting a higher education. It's because he goes to a state university with lower tuition. So can we still rollover his 529 plan to his Roth IRA penalty and income tax free?
2. On form 5329, it stated that additional tax doesn't apply when including distributions from an education account in income because you used the qualified education expenses to figure the American opportunity and lifetime learning credits. What does this mean?
Thanks!
Q. The overfunding in my son's account is not due to receiving scholarship or not getting a higher education. It's because he goes to a state university with lower tuition. So can we still rollover his 529 plan to his Roth IRA penalty and income tax free?
A. Yes. There does not have to be any reason why the account got over funded. If you just mis-estimated expenses or put in extra money in "just in case", you still qualify for tax/penalty free rollovers.
Q. Are there any other criteria that we have to meet for penalty and income tax free rollover from his 529 plan to his Roth IRA?
A. Yes, but you appear to know about those*; the $35K and $7K/yr limit. There's also the 5 year and 15 year rules. See: https://www.fidelity.com/learning-center/personal-finance/529-rollover-to-roth#:~:text=Under%20certa...'.)
Q. On form 5329, it stated that additional tax doesn't apply when including distributions from an education account in income because you used the qualified education expenses to figure the American opportunity and lifetime learning credits. What does this mean?
A. Just like having potential 529 expenses covered by scholarships exempts you from the 10% penalty, having used expenses to claim an education credit also exempts you from the penalty on a 529 distribution in the same amount if used to claim the American opportunity or lifetime learning credits.
*Here's an excellent summary of the rules (Google AI):
"Yes, it is possible to roll over funds from a 529 plan to a Roth IRA, but there are several conditions that must be met:
Hi Hal_Al,
Thank so much for your response! It's really helpful.
By the way, the google AI on Roth IRA has the income limit but when I searched online from smart529.com, it stated that Roth IRA income limits do not apply for this type of contribution. Just want to check with you on that again.
There is no income limit (high income will not disqualify you from making a Roth IRA contribution via a 529 rollover). But there is requirement to have compensation (earned income) in the year you do the rollover.
"Does the beneficiary need a job or have already contributed to the Roth IRA? The beneficiary must have earned income that at least equals the amount to be rolled over. For example, if you’re planning on rolling over $5,000 in 2024, your beneficiary must have earned at least $5,000 for the year."
"What if the beneficiary makes too much to contribute to a Roth? There is no earned income limit for these transfers. Normally, you can’t contribute to a Roth IRA if your modified adjusted gross income in 2024 is more than $161,000 for single filers or $240,000 for those married filing jointly."
So, effectively, using 529 funds to fund a Roth contribution appears to be a loop hole to the income limit, for a very few people.
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