Mis-timed 529 Distribution

[Rick202]

I took a distribution from a 529 in December 2023 to pay for tuition in January 2024.  Now my 1099Q does not match my 1098T for calendar year 2023 due to the early distribution.  Is there a way to rectify this and not be taxed for the December distribution that did get applied to January tuition?

[KrisD15]

Yes.

If Box 1 does not reflect the payment made with the December distribution, use the "What if this is not what I paid" link under Box 1 on the 1098-T screen and add that amount. 

Be sure to adjust the other way (subtract the amount from Box 1) next year. 

[Pip_12_mn]

Has there been a change in IRS guidance for this? To make a tax free W/D from the 529, the W/D has to happen the same year as the expense. To my knowledge the only exception to the calendar year timing rule relates to claiming the AOTC credit. 

Timing of 529 Plan Withdrawals 

[AmyC]

No. The 1099-Q rules: IRS Publication 970, Tax Benefits for Education states:

If the entire 1099-Q went to qualified expenses, room and board, tuition, etc then you do not need to enter the form. Tuition paid for the first 3 months of the next year also qualify, see page 12, What Expenses Qualify, and page 52 for qualified distributions.

[Pip_12_mn]

As long as you are able to use the W/D for the AOTC or Lifetime learning credit, the distibution and expenses don't have to happen in the same calendar year. If you don't qualify for the credit, such as if MAGI is too high, then all expenses would have to happen in the same calendar year as the 529 distribution for them to be tax free.

You would not have to include the 1099-Q with the return if all the expenses were qualified, but they are not qualified if they dont line up in the same calendar year as distribution, with the exception of qualified AOTC and Lifetime Learning related expenses.

[AmyC]

No. Qualified expenses for education have the same definition as things have changed. See Qualified Education Expenses - Internal Revenue Service which states:

Qualified Education Expenses for Education Credits

Qualified expenses are amounts paid for tuition, fees and other related expense for an eligible student that are required for enrollment or attendance at an eligible educational institution. You must pay the expenses for an academic period* that starts during the tax year or the first three months of the next tax year.

See IRS Publication 970, Tax Benefits for Education  page 45 for AQEE to determine taxability of your distribution using the above definition for QEE.

[Pip_12_mn]

I agree ONLY if you are referring to education credits but not otherwise. Your statement above actually refers to Qualified Education Expenses for Education Credits

The Internal Revenue Code of 1986 has an explicit exception for the AOTC at 26 USC 25A(g)(4) that allows one to prepay expenses for an academic period that begins during the first three months of the next tax year. There is no similar statutory language for 529 plans.

So although you won't find a rule on this explicitly stated anywhere in IRS publications or tax forms, the prevailing view by tax professionals is that 529 withdrawals must match up with the payment of the qualifying expenses in the same tax year. If you withdraw the money in December for a tuition bill that isn't paid until January, you risk taking a taxable withdrawal because you didn't have sufficient qualified education expenses during the year of withdrawal.

Timing of 529 Plan Withdrawals 

How to Take a Tax-Free Distribution in 4 Steps 

The tricky timing of 529 savings account withdrawals 

Step 2: Determine When to Withdraw

You should take 529 plan distributions during the same year you paid for the qualified expenses. For example, do not include second-semester tuition expenses that you paid for in December of the previous year.

It doesn’t matter if you withdraw funds in January for expenses not paid until August. Or if the withdrawal occurs in December for expenses previously paid during that year. Make sure they match up within the same calendar year, not the academic year.

If you withdraw the 529 money in December for a tuition bill that isn’t paid until January, you risk not having enough QHEE during the year of the 529 withdrawal. Likewise, if you take a distribution in January to pay for expenses from the previous December, that distribution will be non-qualified. 

Towards year-end, 529 account owners should determine exactly how much was spent on qualified expenses during the year and make the appropriate “catch-up” distribution from the 529 plan. As part of this process, determine if the AOTC is maximized by paying second-semester college bills in December versus January.