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Distributions from 529 plans used for qualified education expenses are tax- and penalty-free, if the amount is equal to or less than the designated beneficiary's qualified education expenses. For distributions that are more than the individual's qualified education expenses, the earnings may be subjected to tax and an additional 10% early-distribution penalty. Some States allow qualified individuals, as defined by the State, to claim tax deductions for contributions they make to 529 plans, If a tax deduction was allowed, State taxes may also apply to a distribution of amounts other than earnings.
Qualified Education Expenses
Generally, qualified education expenses include the following:
- expenses required for the designated beneficiary's enrollment in and attendance at an eligible school, which include colleges, universities, vocational schools and accredited post-secondary educational institutions that are eligible to participate in a student aid program administered by the Department of Education.
- tuition and fees
- books, supplies and equipment
- academic tutoring
- room and board
- uniforms
- transportation
- expenses of a special needs beneficiary that are necessary for that person's enrollment or attendance at an eligible educational institution.
Tax Treatment of Distributions
A distribution from a 529 plan that is not used for qualified educational expenses may be subjected to income tax and an additional 10% early-distribution penalty. The penalty will be waived, however, if the distribution occurs for any of the following reasons:
- The designated beneficiary dies, and the distribution goes to another beneficiary or to the estate of the designated beneficiary.
- The designated beneficiary becomes disabled. A person is considered disabled if there is proof that he or she cannot do any substantial gainful activity because of a physical or mental condition. A physician must determine that the individual's condition can be expected to result in death or continue indefinitely.
- The designated beneficiary receives any of the following:
- a qualified scholarship excludable from gross income
- veterans' educational assistance
- employer-provided educational assistance
- any other nontaxable payments (other than gifts, bequests or inheritances) received for education expenses
- The distribution is included in income only because the qualified education expenses were taken into account in determining the 'Hope Credit' or 'Lifetime Learning Credit', both of which are tax credits that reduce the amount of the taxable income of an individual funding a student's education.
- The distribution is made before 2007 and used for qualified higher-education expenses but included in income because it was paid from a 529 plan established and maintained by an eligible educational institution.
On a State level, the tax treatment for distributions varies. Individuals should consult with their tax professional to determine how distributions from their 529 plans will be treated for tax purposes.
Next: 529 Plans: Conclusion
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