CA Expanded use of 529 Funds

[nicedsf]

In the instructions for CA state "Expanded use of 529 funds" it says to "Enter the adjustment below".  There are no instructions on what to put in the for the adjustment.  If I use 529 funds for high school tuition, is it the amount of the 529 withdrawal?  Is there an additional 2.5% penalty?

[DavidS127]

According to the California instructions, 529 account distributions used for elementary and secondary education [deducted on the federal return] are added back to California income for tax purposes.  So, that amount must be added back to your CA income, and the question you referenced is likely for that.

[nicedsf]

I believe the position of the CA FTB is: 

"Note for California taxpayers: The California Franchise Tax Board (FTB), in its role as the State's tax authority, has determined that current California State tax law does not conform to the new federal tax treatment. This means that, for California taxpayers, the earnings portion of any distribution from any 529 plan to pay for tuition expenses at a public, private or religious elementary, middle, or high school or any amount rolled-over from a qualified tuition program to an ABLE account may be subject to California income tax and an additional 2.5% California tax."

My question is, how do I enter this in TurboTax?  I can enter the earnings portion in the "Expanded use of 529 funds" box [CA(540) Section B, line 8, (f) "Other"], and that will add the earnings back to my CA income, but I don't see a place to enter the 2.5% penalty.  I see no instructions for the penalty in the FTB instructions.

[nicedsf]

This is my solution to match the description above:

T = marginal tax rate (9%)
A = Adjustment amount to enter
P = penalty (2.5%)
E = Earnings

Enter an adjustment amount so that the adjustment times the marginal tax rate yields the same amount of tax that would be incurred at the marginal tax rate plus the 2.5% penalty.

E * (T + P) = A * T
A = (1/T) * E * (T + P)
= E * (1 + P/T)
= E * (1 + 0.28)
= 1.28 * E

So enter 1.28 * the earnings amount as the "Expanded use of 529 funds" adjustment.

[DavidS127 · Accepted solution]

This FTB website has information on Additional tax on early distributions at 2.5%. Although it is specific to retirement plans, I suspect CA is using the same form for 529 plan distributions considered "early" in CA. 

The link to the Form 3805P at the bottom of that page takes you to the form, and you can see that Part II is for your situation.  But,  Line 6, Distributions.....not subject to additional tax refers you to the instructions.  The link to the instructions for some reason takes you to an email sign-up page to get the instructions emailed to you.  But, you can access the 2018 CA Form 3805P Instructions at this link.  Using the 2018 instructions, all of your "early distributions" on Line 5 are subject to the 2.5% additional tax.

The regular income should calculate correctly when you enter the earnings.  For the penalty, you will need Form 3805P, so look for that form or "additional tax/early distribution" section in the CA state return interview questions.

[nicedsf]

Ok, that looks like a better approach.

Added form 3805P with the total distribution on line 5, which generated the correct 2.5% tax into 540 line 63.