CA 529 withdrawal for high school: TT does not include 2.5% tax or form 8305P

[aharoneN_34]

Hello,

I’ve spent over an hour on the phone with TurboTax Live help, and although they have tried to be helpful, no solutions were forthcoming, yet it seems to me that it should be a fairly straightforward process. Below I am using rounded figures to make the arithmetic easier.

I have a CA 529 college savings account for my grandson. He is currently attending a special high school requiring a tuition and I withdrew $7,000 from it in 2021. A total of $3,000 of it was earnings and $4,000 was the contribution, i.e. the basis, money I deposited into the account over the years. These figures are confirmed by the 1099-Q I received from the 529 plan. As long as the withdrawal does not exceed $10,000 per year, there is no federal taxation on this 529 withdrawal (though there is the ability to post this withdrawal and its full deduction on the federal return), but California imposes both an income tax and an additional 2.5% tax on the earnings portion of the withdrawal. TurboTax handles the regular income tax portion perfectly; It adds the $3,000 to my income and computes the CA tax on it and adds it to my CA income tax due. However, it does not seem to add the 2.5% extra tax anywhere. In addition, CA requires filing a form 3805P to indicate that the 529 withdrawal was for a secondary school rather than a college, and this too was not done, even though the form has been listed as “available” in TurboTax for at least the past several days.

I hoped that entering this 529 transaction on the federal return (on Miscellaneous income/Coverdell ESA and 529 qualified tuition programs (Form 1099-Q)) would prompt TT to carry this knowledge over to the CA returns and a 2.5% extra tax, as well as a completed form 3805P, would be automatically generated. Neither happened.

On the CA return interview (under Income and adjustments/Expanded use of 529 account funds), I entered the earnings of $3,000. TT correctly computed and added state income tax for this figure, but did not compute and add the extra 2.5% tax, nor did it generate a form 3805P. I got Live Help twice and neither person could resolve this issue, or tell me if I could manually add a form 3805P and somehow add the 2.5% tax. I hope someone can advise me on a way to get past this issue.

Thank you

[AliciaP1]

It would be helpful to have a TurboTax ".tax2021" file that is experiencing this issue.

You can send us a “diagnostic” file that has your “numbers” but not your personal information.  If you would like to do this, here are the instructions: 

Go to the black panel on the left side of your program and select Tax Tools. 

1. Then select Tools below Tax Tools. 
2. A window will pop up which says Tools Center.  
3. On this screen, select Share my file with Agent. 
4. You will see a message explaining what the diagnostic copy is.  Click okay through this screen and then you will get a Token number. 
5. Reply to this thread with your Token number. This will allow us to open a copy of your return without seeing any personal information.  

We will then be able to see exactly what you are seeing and we can determine what exactly is going on in your return and provide you with a resolution.

[aharoneN_34]

Thank you for your prompt and hope-inducing reply. The token number is 930907

[SusanY1]

Thank you for providing this information.   I tested this in both TurboTax online and TurboTax desktop software today (February 20, 2022).  I found that the online version of the program it is calculating the additional 2.5% so long as you enter the amount of the earnings in the manner that you described.  However, it is not doing this in the TurboTax desktop software. 

If you're using TurboTax online, please check to see if you see the updated tax today. If you still do not see it, remove the California return and re-start it.  TurboTax will reimport the data from your federal return and you will just need to answer the California-specific questions again. 

If you are using TurboTax desktop, we will report this issue to the developers but for now, I did find a workaround. 

• While in the California program, click on the "Forms" icon near the upper right of the program
• Click on "Open Form" on the left side of the screen 
• Type in 3805P and click on  "Form 3805P, TP: Retirement Plan Taxes" and then click Open Form
• Scroll down to Part II and enter the earnings on Line 5
• You can then return to the interview by clicking on Step-by-Step in the upper right hand of the screen

We will report the issue to developers for the desktop software, but using the above workaround you should be able to finish and file your tax returns without any issue.  

[aharoneN_34]

Thank you for pursuing this, SusanY1.

I am using the online “Premier” version of TurboTax, using the Chrome browser in Windows. I confirmed that for the Federal return, the correct 1099-Q and 529 information was entered, and is the same data as is present in the “.tax2021” file I created earlier. However, after removing my CA return and then re-entering it, nothing changed. TurboTax again added the correct state income tax for the earnings portion of the 1099-Q, but did not add the 2.5% extra tax, nor did it create a form 8305P. I hope you can help further.

[SusanY1]

I will try again with the Premier version.  Sometimes also clearing the cache and cookies will help if there's been a program update - but give me a little bit of time to get back to you after I walk through the steps in online Premier.  

[SusanY1 · Accepted solution]

I walked back through my steps in TurboTax Premier online (using Chrome as my browser) and was able to see the 2.5% correctly applied.  I'm going to break down the steps I followed exactly. You may have some questions that populate in between the ones that I list.

Before you start your CA return over yet again, I do want you to check to see if the form 8305P is showing in your list of forms.  To do that log in and continue your return.  Once you are working in the return you will see a menu on the left with Tax Tools near the bottom. Cick on Tax Tools and then Tools.  On the screen that pops up, select "Delete a Form".  The forms that are in the return will then populate in a list.  Scroll down to the California section and see if you see Form 3805P, TP (it could also say SP in place of TP, either is fine).  

If you do not see it, I recommend clearing browser cache and cookies before starting over.  The shortcut to get to that option in Chrome is Ctrl+Shift+Del. 

These are the steps that I took to get the program to add the form and the additional tax on the earnings:

First, verify that the 1098-Q is entered as follows in the federal section of the program:

• From the Deductions & Credits menu click Edit/Add beside ESA and 529 Qualified Tuition Programs (Form 1099-Q)
• On the first page you should see Yes for the question "Did you receive a Form 1099-Q..."
• Once you continue you should see the 1099-Q Summary page.  Click Edit here.
• Click through the screens indicating you are the recipient and someone else is a beneficiary.  
• Click on your grandson's name and click Select
• Continue to the 1099-Q entry page.  Verify that you have numbers in the Gross Distribution, Earnings, and Basis boxes and that the Distribution Code is 1
• Continue through the rest of this section until you are back to the summary page and then click Done

Now begin the California return.  Here are the steps I took inside CA return:

• When you get to the screen Here's the income California taxes differently scroll down to Miscellaneous and click Start beside Expanded 529 Fund Amounts
• Enter the earnings only in the box beside Expanded 529 Fund Amounts

Note if you'd like, you can try editing the return for this data before clearing it to start over again you may (especially if you feel like you haven't seen the section described above yet).  

Here is a screenshot of what's before and after the 529 entry area for reference (it's quite a long list of things California handles differently - and they're not in any particular order).

If this still doesn't work, I would recommend moving to the desktop product where you can see the forms and directly enter the data as needed.  We can assist you with transferring your tax data entered already to that program in order to avoid having to start over.  Just reply back if you need those directions or information about the downloadable desktop product. 

 

[aharoneN_34]

Thank you again for a cogent and thorough explanation. I followed all your instructions and suggestions, using first the Chrome browser and then, in case my Chrome was corrupted, Firefox. Both attempts were unsuccessful; Neither the 3805P nor the 2.5% extra tax were generated.

I do want to transfer my data to the downloadable Windows desktop version of TurboTax. It appears to me that on the desktop version, I will need to use the workaround you described in your first response to me, am I correct? And do you know that with this workaround I can not only manually create form 3805P, but also either the program will then add the 2.5% extra state tax automatically, or I can manually add it?

And finally, can we keep this thread open until desktop TurboTax has successfully accomplished the necessary tasks?

[aharoneN_34]

I decided to take the plunge and get TurboTax desktop and follow SusanY1's instructions on the workaround mentioned in her first reply to me. Everything worked as expected and hoped. I filled in line 5 of the 3805P:TP and TT computed the 2.5% extra tax and inserted it on my CA form 540 on the correct line (63).

I'd like to thank the two people who posted replies to this thread: AliciaS1 who promptly requested the information needed to work on the problem; And SusanY1, whose professionalism, persistence and patience provided all the help I needed to resolve the issue.