NY 529 Nonqualified Withdrawal treatment for Refunded Distribution

[MalvinaBasil]

My son’s college Fall 2021 and Spring 2022 expenses were paid with disbursements in July and December 2021 from a New York State 529 account owned by his grandparents and another New York State 529 account owned by me (parent), plus cash (parent) and loans (student).  Before the Spring 2022 semester started, he dropped out and the college is reimbursing him the full amount for the semester.

Fall 2021-Spring 2022 expenses (rounded $):

$50,000 – $30,000            Tuition and qualified expenses less scholarships

$10,000                               On-campus housing-no meal plan

$2,000                                  Laptop and textbook      

Paid:

$15,000 + $5,000              grandparent 529 direct to college Fall 2021 and Spring 2022

$9,000                                  parent 529 direct to college Spring 2022

$3,000                                  loans and cash

Refunded in 2022

$25,000 - $15,000             Tuition and qualified expenses less scholarships

$5,000                                  On-campus housing-no meal plan

If I understand correctly, I can re-contribute the refunded amount to the parent 529 of which he is still the same beneficiary (the grandparent 529 account was closed with the December disbursement) and the earnings portion of the refunded distribution will not be subject to federal tax or penalties.

However, the paragraph in the 529 disclosure booklet states that the earnings portion of the refunded distribution is subject to New York State tax.

“If you withdraw funds and then later recontribute those

funds into an Account, including a Refunded Distribution,

the withdrawal will be treated as a New York Nonqualified

Withdrawal without regard to whether the withdrawal and

recontribution result in income for federal tax purposes.

This means that the amount withdrawn will be included in

your New York State gross income and is subject to

recapture for amounts previously deducted from your New

York State personal income tax”

Who is “you” in that statement?  Since the original disbursements were made directly from the two 529 accounts to the college, the resulting 1099-Q forms are in my son’s name and SSN, so will the portion of the NY non-qualified withdrawal be included in his New York State income? 

Will this create a taxable event for the grandparents?  Their 529 contributions (and subsequent deductions) were made in prior years.

For my own TTax state return, should I not deduct the $9,000 529 parent contribution since it was made and disbursed in 2021?

[MarilynG1]

If the 529 disbursements were made directly to the school, yes, your son would report the 1099-Qs in his return (if he is required to file a return). 

If your son is a dependent on your return, click this link for info on Dependent Filing Requirements. 

New York's 529 site says, "If a college issues a refund of room and board charges, tuition or other fees paid for with 529 plan funds, you can return the money to your 529 plan to avoid having to pay taxes or a tax penalty on the refund."

You can still report your contributions on your return.

This does not create a taxable event for the grandparents. 

Click this link for more info on 529 Tuition Reimbursements. 

[MalvinaBasil]

He isn't required to file this year as his earned income is below the threshold.  We claim him as a dependent on our MFJ tax return.  To clarify, the NY 529 Disclosure Booklet,  https://cdn.unite529.com/jcdn/files/NYD/pdfs/DisclosureBooklet.pdf  (your link just goes to a general 529 Saving for College site), states "while the earnings portion of a Refunded Distribution would not be subject to federal income tax or the Federal Penalty, it is subject to New York State tax. See Section 7. Important Tax Information—New York State Tax Information".  Given that, would my son claim the earnings portion of the refunded distribution (even though we will re-contribute it within 60 days of refund) as income on his 2021 TTax NYS return?

[AmyC]

Yes. For NY, the 529 earning and prior deductions must be claimed. Please see page 5 for NY filing requirements. He may not be required to file a NY return.

The NY 529 plan stays out of qualified/ non-qualified. They just distribute the money. You can read this on Page 19 of  NYs 529 plan booklet, which says: For New York State taxpayers, Qualified Rollovers will be subject to New York State income taxes on the earnings portion, as well as the recapture of any previous New York State tax deductions taken for contributions to the Account. See Section 7. Important Tax Information—New York State Tax Information.

Then your responsibility kicks in on, page 36, where section 7 simply says:

Because it is your responsibility to verify contributions, withdrawals, and transfers, it is important for you to keep all records, invoices, and other documents regarding your Account to support: • Expenses that you claim to be Qualified Higher Education Expenses, K–12 Tuition Expenses, Apprenticeship Program Expenses, or Qualified Loan Repayments. • Withdrawals because of the death or Disability of, or receipt of a Qualified Scholarship by, your Beneficiary. • The earnings component of and compliance with the timing requirements applicable to Qualified Rollovers. • The earnings component of contributions funded from Qualified U.S. Savings Bonds or education savings accounts. • Refunded Distributions.