33.6 Distributions From Qualified Tuition Programs (Section 529 Plans)
The portion of a QTP distribution that is allocable to a recovery of contributions to the plan (basis) is not taxable. This is true whether the plan is a state QTP or a private educational institution QTP. A beneficiary who receives a distribution of earnings from a state or private QTP to pay college costs does not have to include the earnings in income if the total distribution does not exceed “adjusted qualified higher education expenses” for the year, as discussed below.
On Form 1099-Q, which you should receive from the plan paying the distribution, the gross distribution in Box 1 is divided between earnings in Box 2 and the return of investment (or basis) in Box 3.
Qualified higher education expenses.
For purposes of figuring if part of a distribution from a QTP is taxable (see below), qualified higher education costs are tuition, fees, books, supplies, and equipment required for enrollment or attendance at an eligible educational institution, which is any college, university, vocational school, or other postsecondary school eligible to participate in federal student aid programs.
Reasonable room and board costs for a designated beneficiary who is at least a half-time student also qualify. The limit that is considered reasonable for room and board expenses is the greater of the room and board allowance determined by the eligible institution for federal financial aid purposes or the actual amount charged for a student residing in housing that is owned and operated by the eligible educational institution. In the case of a special needs beneficiary, the definition of qualifying expenses includes all expenses that are necessary for that person’s enrollment or attendance at an eligible institution.
Figuring the taxable portion of a distribution from a QTP.
Whether or not a distribution of earnings from a QTP is taxable depends on whether the distribution exceeds adjusted qualified higher education expenses. The qualified higher education expenses paid during the year must be reduced by any tax-free assistance such as scholarships, Pell grants, veterans’ assistance, and employer-paid expenses. If an American Opportunity or Lifetime Learning credit is claimed for the year of the distribution, the expenses taken into account in determining the credit also reduce qualified higher education expenses. If after the reductions the resulting adjusted qualified higher education expenses equal or exceed the total QTP distribution, the entire distribution is tax free. If after the reductions the resulting adjusted qualified higher education costs are less than the total QTP distribution, part of the earnings (shown in Box 2 of Form 1099-Q) is taxable. The Example below illustrates the computation of the taxable amount.
If earnings are taxable, a 10% “additional tax” may also be due, but there are exceptions for distributions that are taxable merely because qualified expenses had to be reduced by tax-free education assistance or expenses taken into account in figuring an American Opportunity or Lifetime Learning credit. The additional tax is figured on Form 5329.
| Total qualified higher education expenses | $8,500 | |
| Less: Tax-free scholarship | −3,000 | |
| Less: Expenses taken into account in figuring American Opportunity credit | −4,000 | |
| Equals: Adjusted qualified higher education expenses (AQEE) | $1,500 |
Coordination with Coverdell ESA distributions.
If distributions from both a QTP and a Coverdell ESA (33.11) are received in the same year and the total distributions exceed the adjusted qualified higher education expenses, the expenses must be allocated between the distributions. Assume that in the above example Marta had withdrawn $3,000 from her QTP and $600 from her Coverdell ESA instead of taking the entire amount from her QTP. Marta would allocate $1,250 of the expenses to the QTP distribution ($3,000 QTP / $3,600 total distribution × $1,500 expenses = $1,250), and $250 of the expenses to the ESA ($600 ESA/$3,600 distribution × $1,500 expenses = $250). She would then figure the taxable portion of earnings from each distribution based on the allocable $1,250 or $250 of expenses.
Contributor’s loss on QTP investment.
If the entire account is distributed and the total investment in the account has not been recovered, the contributor may be able to claim a loss. However, the loss is a miscellaneous itemized deduction subject to the 2% of AGI floor on Schedule A, Form 1040.