Student Loan Payoff with 529 money

[paul7616]

I am the co-signer on a student loan for a child. I used money from a 529 to payoff one of her loans. About $5000. of the 529 is listed as taxable income. Can any of this be deducted since it was used for higher education?

[KarenJ2]

The SECURE Act allows families to take tax-free 529 plan distributions for student loan repayment. Principal and interest payments toward a qualified education loan will be considered qualified 529 plan expenses. However, the portion of student loan interest that is paid for with tax-free 529 plan earnings is not eligible for the student loan interest deduction.

The law includes an aggregate lifetime limit of $10,000 in qualified student loan repayments per 529 plan beneficiary and $10,000 per each of the beneficiary's siblings. Siblings may include a brother, sister, stepbrother or stepsister. A 529 plan account owner may change the beneficiary at any time without tax consequences.

[valprice7]

I used the 529 distribution to pay off a sibling's student loan.  How do I enter that in TurboTax?  When I correctly answer the questions, the distribution shows up as taxable.

[Hal_Al]

If the sibling was not the beneficiary of the plan (or the sibling of the beneficiary), the distribution is taxable and subject to the 10% non qualified distribution penalty.

If the sibling is the beneficiary, just don't enter the 1099-Q.  When the box 1 amount on form 1099-Q is fully covered by expenses (loan payments up to $10K qualify), TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records.

On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 

[valprice7]

The SECURE Act of 2019 changed the law to allow loan debt of the beneficiary's siblings to be paid off tax-free as well.  Unless I'm reading it wrong?  And if I don't report it, isn't the IRS going to come back and contest that as they do with missing 1099-NEC and -MISC income? - Based on your quote of instructions above, it appears not!

[valprice7]

Actually, I just found it.  The last question is "Did you make any payments on qualified education loans for the designated beneficiary?"  You have to answer this question YES, even though the payment is on a sibling's loan.  Then it pops up another question:  Enter any principal or interest paid on...loans of the designated beneficiary (OR A SIBLING)....

[Hal_Al]

I took your post to be your sibling, not the sibling of the beneficiary.  You are correct, the beneficiary's sibling is the same as the beneficiary for a qualified distribution.

Yes, there is a chance of hearing from the IRS because the 1099-Q is not reported.  But there is no way to report it if it's a fully qualified distribution.  Entering it in TT still enters nothing on the tax forms.

Others have reported trying to use workarounds, but they still got an IRS notice.  I have noticed that the number of people reporting an IRS notice, for a missing 1099-Q, has dropped significantly, in the last year.  I think the IRS has noticed the "error of their ways".

[m67j66]

In what section are these questions asked?

[Hal_Al]

Q. In what section are these questions asked?

A. In TurboTax (TT), enter at:

Federal Taxes Tab (Personal for H&B version)

Deductions & Credits

-Scroll down to:

--Education

  --ESA and 529 Qualified Tuition Programs (1099-Q)

The interview will eventually present the loan payment question. There is no short cut, you have to go thru the 1099-Q interview. 

[nmonty2]

Do we not include the 1099-Q ? Looking for guidance here when the funds were used to payoff my child's student loan (less than 10K). Thanks.

[Hal_Al]

Q. Do we not include the 1099-Q ?

A. Yes.You can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including student loan payments (up to $10K) to cover the distribution. When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. You also cannot count expenses that were paid by tax free scholarships. You cannot double dip! 

References:

1. On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 
2. IRS Pub 970 states: “Generally, distributions are tax free if they aren't more than the beneficiary's AQEE for the year. Don't report tax-free distributions (including qualifying rollovers) on your tax return”.