Saturday, February 23, 2013

The Secret Tax Treatment of Qualified Tuition Programs/529 Plans?


Families are having a tough time paying for college with rising costs pricing many out of a college education. Over the last 20 years public university tuition and fees have soared 30%. At the same time, middle class incomes have remained the same. Qualified Tuition Programs (QTP) or 529 Plans are the most popular savings vehicles to help pay for college because of their tax benefits. However, these plans may not be as great as you think because there are hidden tax liabilities that most families and CPA's are not aware of.

What is a QTP/529 Plan?

It is a state sponsored plan that allows families to pre-pay or either contribute to an account to pay for your child's qualified education expenses at an eligible educational institution.

Tax benefits of a QTP/529 Plan

As long as the withdrawal is less than or equal to the beneficiary's adjusted qualified education expenses, no tax is due. Stated another way, taxes will be due when the QTP/529 Plan withdrawal is greater than the beneficiary's adjusted qualified education expenses.

Who can withdraw?

First of all, withdrawals can only be taken by the account owner who is usually the parent or grandparent. The beneficiary is the other person who can also withdraw funds. When withdrawals are taken from the account a withdrawal form is submitted and the fund administrator will issue a 1099-Q (IRS reporting form) to the party that receives the funds. It is important to note that any tax consequence will not be stated on this form, taxes must be determined by the parent or an accountant.

What are the funds be used for?

The funds are designated for qualified education expenses (QEE) - tuition and fees, room and board, books and supplies, required equipment, computer and internet access, and special needs. The original contributions to a QTP/529 Plan are tax free but a portion of the earnings can be taxed even if the money was used to pay for QEE.

Taxable Withdrawal Example

Alyssa's parents opened a 529 college savings plan for her. Over the years they contributed $20,000 into the account. The balance on the date of the withdrawal was $29,000. In the fall, Alyssa enrolled in college and had the following QEE:

Tuition and Fees $11,000

Books and Supplies $ 1,000

Room and Board $ 6,000

Total QEE $18,000

She paid for her college expenses from the following sources:

Tax free education benefits

Scholarships/Grants $10,000

Lifetime Learning Credit $ 2,000

Total education benefits reduction $12,000

529 Plan $ 8,000

Before Alyssa can determine the taxable part of her withdrawal, she must reduce her total qualified expenses by any tax free education assistance.

Total QEE $18,000 - tax free education benefits $12,000 = $6,000 Adjusted qualified education expenses (AQEE)

Since the AQEE $6,000 is lower than the 529 withdrawal, part of the earnings will be taxable.

Alyssa's 1099-Q form shows that $1,600 of her 529 withdrawal is earnings. Therefore, her parents or CPA figures the taxable part of the withdrawal as follows:

$1,600 earnings X $6,000 AQEE / $8,000 529 withdrawal = $1,200 tax free earnings

$1,600 earnings - $1,200 tax free earnings = $400 taxable earnings

Alyssa must claim $400 in income on her tax form as withdrawn 529 Plan earnings not used for AQEE.

QTP/529 Plan withdrawals are not as simple as you might think. The process is quite complicated and without the help of an expert on your side - saving for college could be costly if you are not aware of the tax consequences and how they apply to your circumstances. But you don't have to navigate the system alone, seek the assistance of a college planning professional. For more information on other education tax benefits consult IRS Publication 970.

No comments:

Post a Comment