Q. I'm doing her taxes and right now, the $81K gross distribution on the 1099Q is giving us a $14K tax bite. Does that sound "normal?"
A. Maybe, depending on your tax bracket. Several issues come up. First, as AmyC pointed out, only the earnings portion is taxable. The $14K may also include the 10% non qualified distribution penalty (the penalty is also on the earnings, not the total distribution), which you might be able to avoid. Depending on her age and other income, the "kiddie tax" may apply (she's taxed at the parent's marginal tax rate).
There are exceptions to the penalty, if the distribution was only taxable because the student had scholarships or the parents use some of the tuition to claim the education tax credit.
There is some disagreement on the timing of the distribution, in order to claim the penalty exception. “Most believe and have written that the distribution must be made in the same year that the scholarship paid for the tuition expense,” Peter J. Greco, CPA, founder and chief tax strategist at the CSI Group, says. “However, IRS 970 is silent as to when the money must be withdrawn. If Congress is trying to encourage 529 plans, then it makes good policy sense that the withdrawals can be made any time prior to graduation.”
Coverdell ESA assets must be withdrawn by the time the beneficiary reaches the age of 30.
