How does TurboTax handle 529 withdrawals that are: 1. Not for educational purposes, but 2. Not penalized because the plan beneficiary attends a US Service Academy?

[jadcom]

How does TurboTax handle withdrawals from 529 Plans that are: (1) not for educational purposes, but (2) not subject to the 10% tax penalty because the plan beneficiary is (a) attending a US Service Academy, and (b) the amount withdrawn does not exceed the cost of advanced education?  Statutory references are:
26 USC 529(c)(6)
26 USC 530(d)(4)(B(iv))
10 USC 2005(d)(3)

[Hal_Al]

The earnings portion of the distribution is reported as taxable income on line 8 of Schedule 1. On form 5329, TurboTax (TT) will enter the taxable amount on line 5 and subtract the same amount  on line 6, so that the amount subject to the 10% penalty (on line 7) is zero. 

The 1099-Q interview, in TT,  will ask if the beneficiary attended a service academy. 

In TurboTax (TT), enter at:

Federal Taxes Tab (Personal for H&B version)

Deductions & Credits

-Scroll down to:

--Education

  --ESA and 529 Qualified Tuition Programs (1099-Q)

When asked "Who's the student", do NOT check "the distribution was not used to pay any education expenses.  If the cadet is not listed as a dependent, on your return, select "Someone else not listed here".  Leave the educational expenses boxes empty.

[jadcom]

Thanks.  I will review in greater detail, but let me ask this follow-up. 

Students at service academies still incur expenses that would be qualified expenses for 529 purposes, like books, uniforms, and computers.   Are these expenses entered in a dialogue or directly on the worksheet?  I am looking at the 2020 worksheet called "Payments from Qualified Education Programs (Under Sections 529 and 530)."  Under the section called "Qualified Tuition Program (QTP) Computation of Taxable Distribution," I see that line 2.c. provides for "Adjusted Qualified education expenses attributable to this QTP."  Should I override this line ($0) with the amounts I withdrew to cover the computer, uniforms, books, etc.?

[DawnC]

They (books, uniforms, and computers) are entered into a dialogue box in the Education Expense section.   It goes on the screen titled Did you pay for Books or Materials to Attend school?  which is part of the 1098-T interview.    Make sure you have already entered your 1099-Q.   And after you go through the 1098-T interview and enter any deductible expenses, you will be able to review your entries.   When you review your entries, the first screen will say ''Let's get your additional Education Expenses''.   Click continue, and you will get the screen below.    'Room and Board' is highlighted, but use whatever category is appropriate for the expense.  

[Hal_Al]

Yes, you can enter it on the worksheet (line 2c is correct) in the desktop software (not online).  But, manual entries may prevent e-filing. Doing in the interview, as described by DawnC, is better.

However if the academy provides tax free stipends and allowances that can be used to pay for these items, you cannot double dip and claim them as eligible for 529 plan distribution.

[jadcom]

How does TT treat the US Merchant Marine Academy (USMMA), and book expenses?  USMMA is the only one of the five US Service Academies that is on the DOEd list of schools (#002892).  USMMA, however, does not issue a 1098-T because it does not charge tuition.  Further, it does not appear to have a federal tax ID number (since it is a Federal institution).

[Hal_Al]

Cadets & Midshipmen cannot claim education credits.  Reference: page 17 at

https://static.e-publishing.af.mil/production/1/usafa/publication/usafai65-101/usafai65-101.pdf

[jadcom]

Thanks, I genuinely appreciate your effort. 

I've seen that, but it applies to the USAF Academy, which is not listed on the DOEd list of eligible schools.  USMMA, however, is listed: School Code 002892.  Midshipmen at USMMA do not receive military pay, stipends, or other compensation.  Since they do not pay tuition, the school does not issue a 1098-T.   

[jadcom]

To go even further with this and the distinctions between the academies:

A.  To be an "eligible school" IRS says to look at either the DOEd accreditation list or the DOEd's student aid list.  See https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/eligible-educational-ins....

B.  The two DOEd lists are different.  While all service academies are on the accreditation list, only USMMA is on the student aid list.  

[Hal_Al · Accepted solution]

Apparently, USMMA is a college, for educational tax benefits.  So, the out of pocket book  expenses are eligible for a credit or deduction.

In TurboTax (TT), enter at:

Federal Taxes Tab (Personal for H&B version)

Deductions & Credits

-Scroll down to:

--Education

  --Education Expenses

After answering no to the getting a 1098-T question, answer yes to qualifying for an exception.  That will get you the screens to enter expenses. 

[jadcom]

Hello again!

Well here we are in 2022, experiencing the joy of TT, 529 plans, and US Service academies.  

I am not convinced that TT developers treat US Service Academies correctly for 529 purposes. Four military academies (West Point, AF, Navy, and Coast Guard) are not colleges for DoED purposes, but US Merchant Marine Academy ("USMMA") (DOT/MARAD) is a college on DoED's list of qualifying institutions. This means that qualified expenses at USMMA for books, computers, etc. should be treated as tax free withdrawals from a 529 plan, whereas they are not for the military academies. The academies are treated the same, however, for the 529 withdrawals in terms of avoiding the 10% penalty.

Based on the results I am getting for one kid at a DOD academy, and another at USMMA, I do not think that TT recognizes these differences. To avoid the 10% on a large withdrawal, I must tell the system that my kid was at a "military academy." When I put in qualified educations expenses for the USMMA kid, it tells me I cannot take those.

I do not know if there is a solution.

[RobertB4444]

If you receive a 1099-Q and spend all of the money taken out on qualified education expenses then you don't report it on your tax return.  If you take the money out and you don't spend it on qualified education expenses then you do report it.  It sounds like the MIlitary academies have qualified expenses associated with them.  So the standard advice is save all of your receipts that add up to the amount that you took out of the 529 and be ready in case you get a letter from the IRS but don't worry about it otherwise.

[jadcom]

What is TT's definition of "military academy," as it uses the term in its software?  This is an important question for two separate tax situations pertaining to 529 plans.

1.  The 10% penalty on Withdrawals.  26 USC 529(c)(6) provides that the 10% penalty in section 530 applies to withdrawals not used for qualifying expenses.  Section 530(d)(4)(B)(iv) provides an exception, however, for beneficiaries who "at the United States Military Academy, the United States Naval Academy, the United States Air Force Academy, the United States Coast Guard Academy, or the United States Merchant Marine Academy, ...). The law lists the academies, and does not use the phrase "military academy."  TT does not appear to recognize that the US Merchant Marine Academy is NOT a military academy because my tax goes UP improperly if I do not check the box relating attendance at a "military academy."

2.  USMMA is a US Service Academy that Accepts Aid.  Students at USMMA do not get paid for attendance, and do have fees for books, materials, etc.  USMMA charges some fees, is on the DoED list of qualifying institutions, and does participate in aid programs.  Military academies do not.   USMAA does not charge "tuition," however, so it does not issue the 1098-T.   Unfortunately, TT does not allow me to treat the books and fees portion of my 1099-Q as a tax exempt withdrawal, i.e., it is treating USMMA as thought it were a "military academy" that does not participate in DoED financial aid programs.  

This needs to be corrected in the software.  Not all US Gov't service academies are "military academies," but I suspect that there is a logic error based on the erroneous and ambiguous term "military academy."  

[Hal_Al]

Whether you call the USMMA situation a military academy exception or a scholarship exception, the outcome is the same, the 10% nonqualified distribution penalty is waived.  

[jadcom]

While still disallowing the savings that should be associated with funds withdrawn for expenses.  And that, specifically, it the problem.