529 Plan Closed Account

[BudgetNuts]

Hi all, question on closing the 529 plan and taking the final withdrawals. So we had money left after using it for child's college.  The earnings portion was about $20,000. My question is on the state of Illinois tax return.  As the owner of the 529, our deposits over the years when we were contributing to the plan were deductible in Illinois but now the earnings portion I suspect we have to pay state taxes on. There is a question on the Illinois tax return about income received from 529s. Since that amount is already included in my federal return do I need to add it anywhere on the Illinois return? There are two sections that are confusing pertaining to the distribution and income for 529s. Any help is appreciated. Thanks

[hbl3973]

BudgetNuts,

The  Bright Start Tax Center underscores:

"Keep in mind – if funds are spent on non-qualified expenses, you’ll pay taxes on your earnings, plus an additional 10% federal tax. And the amount of any deduction previously taken for Illinois income tax purposes is subject to recapture when withdrawn for non-qualified purposes or if assets are rolled over to a non-Illinois 529 plan. Other states offer similar benefits to their residents, so if you live outside of Illinois you’ll want to understand your own home state plan and its benefits and features."

so you do need to check that Yes box and that leads to IL Schedule M line 9.  The instructions for that line read:

"Line 9 — Recapture of deductions for contributions to college savings and ABLE plans withdrawn for nonqualified expenses or refunded
If you withdrew funds or received a refund of contributions from a qualified tuition program or ABLE program, the funds were not used for qualified expenses at an eligible institution, and the withdrawal or
refund did not result from the death or disability of a beneficiary of the program, include the amount equal to the amount of deductions you claimed for contributions related to the nonqualified withdrawal or
refund amount. Enter the smaller of
   - the amount of deductions you claimed for amounts contributed to an Illinois college savings plan or Illinois ABLE plan, minus any amount recaptured on Line 7 for this year and any deductions recaptured in prior years for that plan, or
  - the refund or amount you withdrew during the tax year that was not used for qualified expenses in an eligible institution plus any refund of contributions."

It is not clear whether you closed that 529 account in the same tax year as the one in which you made your last qualified withdrawal.  If it was in a later year, then Box 3 of the 1099-Q is the remaining basis and is the amount to use for the first bullet point.  Box 1 would most likely be the amount for the second bullet point in your situation.  Since Box 1 = Box 2 + Box 3, the amount in Box 3 would be the amount that is entered on that Line 9.

If the account was closed in the same year, you'll need to split out the remaining basis from Box 3 and the qualified withdrawal from Box 1.

[Hal_Al]

Note that the IL tax on the  "recapture" of the previous year deductions is in addition to the tax on the earnings portion of the distribution, that transfers from the federal return. It's not double taxation. It's tax on two different pieces of "income".  It works this way in most other states, too. 

[BudgetNuts]

Hi there....thanks for the reply. The last qualified withdrawal was in the same year and my son received a 1099-Q and 1098-T for that withdrawal. 

Once he graduated, as the owner, I closed the account. When I closed the account and took the final withdrawal it was a non-qualified withdrawal.  Here is my example:

1099-Q

Box 1 - 40,000 Total Distribution

Box 2 - 15,000 Earnings

Box 3 - 25,000 Basis

The Earnings are showing up as other income on my federal return.

Illinois is the issue.  The language in turbotax is a bit confusing. It states if the earnings are already included in the federal return not to include it. Per the. reply provided here, it implies I have to identify the amount again so Illinois will penalize me for closing account? What fields in turbotax apply? Also what amounts get reported?

[BudgetNuts]

Can someone clarify for me please? On Turbotax it states:

"All prior year deductions claimed for Illinois qualified 529 savings plan contribution".

Does this mean I have to review 15 years worth of Illinois returns to add up the deductions I took in the year that I made contributions to the 529 plan?  Seems terrible I have to go back that far. Thanks

[Hal_Al]

Q. Does this mean I have to review 15 years worth of Illinois returns to add up the deductions I took in the year that I made contributions to the 529 plan?  

A. Maybe.  You have to determine that from your own records. 

But the $25,000 shown as basis, on the final 1099-Q, may be the additional  amount to be taxed.  That assumes, that you deducted all prior contributions made to the fund.  All prior distributions, being qualified,  would have used up the other money, basis and earnings, so that the  remaining basis ($25,000) consists of previously deducted contributions. 

On the other hand, none of it (the $25K) may be taxable, if your previous qualified distributions already used up the basis consisting of deductible amounts.  That's probably not likely, since IL has such a  a high deduction limit. 

[BudgetNuts]

Need some additional info please.  Why for Illinois will I get taxed twice?

Which section of IL Education section in turbotax am I completing? Distributions or Withdrawals? I closed the account.

 Distribution shows this:  Enter income you received in 2022 from a College Savings and Tuition Program (529 Plan) or ABLE account that was not included in your federal income. Do NOT include earnings from the following tax-exempt programs.  *** The income was already included in my federal return so it looks like I get taxed on it twice?

OR do I also fill this part out?

Distributions From college savings plans

Enter the amount of distributions you took from "Bright Start", "College Illinois", or "Bright Directions" in 2022 that was included in your federal income.

[Hal_Al]

Q. Why for Illinois will I get taxed twice?

A. You're not getting taxed twice, at least not on the same income.

Illinois is  taxing  you on two pieces of income, whereas the feds only taxed one piece (the earnings).  Although it appears that IL is taxiing you on your "after tax" basis, that's not really what's happening. IL is taxing you on the recovery of a previous year deductions that are now no longer valid. 

I don't have the IL program.  But, based on similar situations on other state software, you enter the income at:

Income you received in 2022 from a College Savings and Tuition Program (529 Plan) or ABLE account that was not included in your federal income.

[BudgetNuts]

Thank you so much but I have a clarifying question.  

On the federal return the earnings from the 1099-Q are included on line 8 as other income.

On the IL return on Line 1 federal adjusted gross income its the same (earnings included).

The gross distribution from the 1099-Q shows up on the IL return as other additions to income.  And the total income on the IL return includes both the adjusted gross income (earnings included) and the gross distribution from 1099-Q (earnings included). That to me is doubled. 

I think on the IL return it is counting it twice. Seems to be I should only have the total IL income minus what is already included in the federal gross income which already has the 1099-Q earnings in the adjusted dollar amount.  Can someone with IL familiarity with the form help on this? Appreciate everyone's advice but something seems incorrect as to how I am entering and how turbotax advises where it goes 🙂

[Hal_Al]

It sounds like that 2nd entry:

"Distributions From college savings plans

Enter the amount of distributions you took from "Bright Start", "College Illinois", or "Bright Directions" in 2022 that was included in your federal income"

might be where you back out the double taxed part. 

paging @hbl3973 

[BudgetNuts]

When I do that it increases my tax instead of decreasing it?

[BudgetNuts]

So looking at this again, do I only report to Illinois the basis amount on the 1099-Q as that would be the amount that I would of taken the deduction on not the earnings? The earnings amount is included in the adjusted gross income that carries over from the IRS 1040?

[Hal_Al]

Q. So looking at this again, do I only report to Illinois the basis amount on the 1099-Q as that would be the amount that I would of taken the deduction on not the earnings? The earnings amount is included in the adjusted gross income that carries over from the IRS 1040?

A. Yes.  That's how I understand it and that's the way I would enter it on my state's (Ohio) software.  So, I assume the IL program is similar.

The one difference is I wouldn't assume the basis on the 1099-Q was all previously deductible (Ohio only allows a $4000 deduction; $2000 until a couple of years ago).  I would dig through my past returns to calculate that number. 

[BudgetNuts]

Illinois allows $20,000 per year for married filing joint. The amount of the basis on the 529 closed was significantly less than that. I have not contributed anything to the 529 since 2015 all contributions were done between 2002 and 2015. 

Do we have any experts on here for Illinois that can confirm your great advice? Just since Illinois is different?

[hbl3973]

OK, the $15K earnings are included in your federal taxable income and the $25K basis is an amount that you had previously deducted on one or more prior year IL tax returns.

The federal government does not tax return of basis.

Use the "Enter income you received in 2022 from a College Savings and Tuition Program (529 Plan) or ABLE account that was not included in your federal income" to enter the $25K basis.  Do not enter the $15K earnings in the IL Educational area.

Bottom line: IL will tax the non-qualified earnings because it is part of the federal taxable income and IL will tax the non-qualified basis distribution because it was previously excluded from IL state tax when it was contributed.