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A 529 distribution is indeed taxable at ordinary income rates for withdrawals that do not reimburse qualified expenses. But USMMA (Kings Point) is not treated the same as USMA (West Point).
Consider this example: A parent has over-saved for his kid to go to college because the kid went to a Federal service academy. In the given tax year, the parent withdrawals $11,000, made up of $1000 for books, computers, etc., and $10,000 to reinvest elsewhere because he will never have more potential beneficiaries. Academies, under the law, are treated differently:
West Point - This cadet is active duty military, not a "student" under the law, and gets paid a stipend to cover books, computers etc. Further, West Point does not participate in Department of Education financial aid programs, and therefore is not a qualifying institution for tax free use of 529 funds. The full $11,000 is taxable at ordinary income rates, but the law (cited in earlier posts) does not impose the 10% penalty because it is a service academy specifically identified in the text.
Kings Point - This cadet is a student under the law, is only in the Naval Reserves, does not get paid a stipend, but does incur various fees for attendance as well as books, computers, etc. Further, USMMA does qualify for Department of Education financial aid programs and does participate. For our parent who withdrew $11,000, the $10,000 should be taxable at ordinary income rates but without the 10% penalty because USMMA is expressly identified (like West Point) in the applicable statute. The $1,000 expense, however, is tax free because the fees reimbursed qualified expenses at a DoED participating institution. As far as I can tell, TT is failing to recognize this situation.
Finally, I am calling foul for that "free ride" comment. While midshipmen and cadets at all service academies incur less monetary expense for their education, they pay in other ways. Life is grueling at academies from sun up to sun down, there is limited privacy, codes of conduct under the UCMJ, and very little free time. All attendees are subject to a 5 year commitment to serve in the Armed Forces at lower pay than they probably could make elsewhere. USMMA cadets can remain in the reserves, but must spend 8 years on a cargo ship or elsewhere in the marine industry. I know college life, and I know service academy life; college is a walk in the park on a sunny day. So stow it with your incredibly ill-informed comment about "free ride."
JADCOM, Esq.
