@circle11 A 529 is broken up into 2 portions, the basis of your initial investment and the earnings portion. The basis of the initial investment would only have potential tax consequences to a state if there were state tax benefits for saving in such states as NY. The earnings which grow tax free though now that would be the tax consequences we need to discuss.
You may be confusing PENALTY vs. PAYING TAXES. The only thing you may not have to pay is a PENALTY. Since the income grew tax free, you would have to pay taxes on the tax free growth.
A 529 can be left and used by any relative, cousin, sister, kids, grandkids, etc and transferred over tax free to any others.
The Penalty is very small. it is 10% and only on the earnings portion. THE ONLY EXCEPTIONS TO THE PENALTY:
In the following situations, the 10% penalty is waived for non-qualified 529 plan distributions, but the earnings portion of the distribution is subject to income tax:
- A beneficiary dies or becomes disabled
- A beneficiary receives a tax-free scholarship
- A beneficiary receives educational assistance through a qualifying employer program
- A beneficiary attends a U.S. Military Academy
- The qualified education expenses were used to generate the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC)
when you go through the 529 withdrawal interview Turbotax will ask you the questions and it will ask you questions related to the scholarship and the school expenses. Make sure you do the entire college interview in order and do not skip any sections and it should calculate everything correctly for you. The penalty is now worse than if you had invested in after tax investments honestly.
529 money grew tax free so all growth would now be taxable if the money was withdrawn and not used for college expenses. To the extent you may have gotten and state benefits on a state return for investing in a 529 such as in NY, there also may be tax consequences.
NOTE A TAX FREE SCHOLARSHIP per the above rules IS ONLY THE PORTION OF THE SCHOLARSHIP THAT WAS NOT USED FOR ROOM AND BOARD. Any scholarship used for room and board can be taxable income.
Section 6693 deals with IRS penalty.
Some IRS notices and documentation on 529's:
https://www.irs.gov/taxtopics/tc313
https://www.irs.gov/irb/2003-33_IRB#NOT-2003-53
https://www.irs.gov/irb/2016-07_IRB#NOT-2016-13
I do not work for Turbotax. I hope this was helpful.
**I don't work for TT. Just trying to help. All the best.
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