33.11 Distributions From Coverdell ESAs
Caution: As noted in the Law Alert at 33.10, less favorable ESA distribution rules will apply in 2013 unless Congress extends the 2012 rules. Without the extension, elementary and secondary school expenses through grade 12 will not be qualified expenses in 2013. Also, the rule allowing an ESA of a special needs beneficiary to continue past age 30 will not apply. See the e-Supplement at jklasser.com for the post-2012 rules.
Tax treatment of 2012 ESA distributions.
A designated beneficiary of a Coverdell ESA is not taxed on withdrawals made during 2012 that do not exceed qualified education expenses. If the total withdrawals in 2012 exceed the qualified education expenses (see below), a portion of the withdrawals is taxable to the beneficiary. The taxable portion is the amount of the excess withdrawal allocable to earnings; see the Example below and the worksheet in IRS Publication 970.
Qualified education expenses for 2012.
In addition to qualified higher education expenses (as defined at 33.6 for QTPs), qualified expenses for ESA distribution purposes include contributions to a QTP (33.5) on behalf of the ESA beneficiary. Also qualifying for 2012 are elementary and secondary education expenses, kindergarten through grade 12. The elementary or secondary school may be a public, private, or religious school. Eligible expenses for elementary and secondary school students include tuition, fees, academic tutoring, books, supplies, special services for special needs beneficiaries, computers and peripheral equipment, Internet access, and software. Software designed for sports or hobbies must be predominately educational in nature. Qualified expenses also include room and board, uniforms, transportation, and supplementary items and services including extended day programs required or provided by the school.
Filing Tip
Coordination with education credits.
If an American Opportunity credit or Lifetime Learning credit is claimed for 2012, then in figuring the tax-free portion of a 2012 Coverdell ESA distribution, qualified Coverdell ESA expenses must be reduced by the expenses taken into account when figuring the credit.
Figuring the tax free and taxable part of a distribution.
If the adjusted qualified expenses of the beneficiary equal or exceed the distribution, the entire distribution is tax free. If a distribution exceeds adjusted qualified education expenses, then part of the earnings included in the distribution is taxable. To determine the amount of adjusted qualified educational expenses, reduce the total qualified education expenses (defined above) by any tax-free educational assistance such as excludable scholarships, Pell grants, veteran’s educational assistance or employer-provided educational assistance. Any expenses taken into account when figuring an American Opportunity credit or Lifetime Learning credit further reduce qualified expenses. The balance of qualifying expenses after subtracting tax-free educational assistance and credit-related expenses is the beneficiary’s adjusted qualified educational expenses. The Example below shows how the taxable portion of the distribution is determined when the total distribution exceeds the adjusted qualified education expenses.
Additional tax on taxable distributions.
Generally, a taxable distribution is subject to a 10% additional tax, which is figured on Form 5329. However, the 10% additional tax does not apply to distributions that are: (1) made to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary, (2) made because the designated beneficiary is disabled, (3) taxable because the designated beneficiary received a tax-free scholarship or educational assistance allowance that equals or exceeds the distribution, or (4) taxable only because the qualified ESA education expenses were reduced by expenses used in figuring an American Opportunity or Lifetime Learning credit.
The 10% additional tax also does not apply to the withdrawal of an excess contribution (and allocable earnings (33.11) before June 1 of the following year.
| Total qualified higher education expenses | $6,200 | |
| Less: Tax-free education benefits | −1,500 | |
| Less: Expenses taken into account in figuring American Opportunity credit | −4,000 | |
| Equals: Adjusted qualified higher education expenses | $700 |
Law Alert
Age 30 duration rule.
If there are assets remaining in a Coverdell ESA when the designated beneficiary reaches age 30, the beneficiary must withdraw the assets within 30 days, unless he or she is a special needs beneficiary. The duration of the account can be extended by changing the designated beneficiary or rolling over the account to a member of the beneficiary’s family who is under age 30; see below.
Rollovers and other transfers.
Withdrawn assets may be rolled over tax free from one Coverdell ESA to another for the benefit of the same beneficiary or a member of the beneficiary’s family if the recipient is under age 30. For example, if a beneficiary still has money in his or her account upon graduation from college, the Coverdell ESA can be rolled over tax free to the Coverdell ESA of a younger sibling. The withdrawal is considered rolled over if it is paid to another Coverdell ESA within 60 days. Only one rollover per Coverdell ESA is allowed during the 12-month period ending on the date of the payment or withdrawal. For rollover purposes, members of the beneficiary’s family include the beneficiary’s spouse, child, grandchild, stepchild, brother, sister (and a sibling’s son or daughter), half-sister, half-brother, stepbrother, stepsister, father, mother (and siblings of parents), grandfather, grandmother, stepfather, stepmother, in-laws, the spouses of any of the above, and first cousins.
The designated beneficiary can be changed to a member of the beneficiary’s family (included in the above list) with no tax consequences if the new beneficiary is under age 30. The new beneficiary will have to withdraw the account balance no later than 30 days after reaching age 30, unless he or she is a special needs beneficiary.
If the beneficiary dies before age 30, the account balance generally must be distributed to the beneficiary’s estate within 30 days of the date of death. However, if the Coverdell ESA is transferred to a surviving spouse or other family member (defined above) who is under age 30, the account may be maintained until he or she reaches age 30. The age 30 limitation will not apply if the new beneficiary is a special needs beneficiary.