Weird 529 withdrawal situation and tax implications

[DLgal]

I figured this board would be best for this question, so here goes.

DH is attending an online university in pursuit of a masters. This particular university has a military affiliation such that they extend in state tuition to out of state students that are active duty. This program requires enrollment which DH did well in advance of paying fall tuition. However, they failed to process his enrollment and charged him the full out of state tuition which was due Aug 28. We had opened up a 529 for him over the summer and transferred assets from our 2 son's accounts to his, to cover the tuition.

I withdrew about $6500 and we paid it to the bursar's office. 2 weeks later, they got around to processing his enrollment and subsequently issued him a credit in the amount of about $3600. They required he provide checking account information so they could refund the money. So, we got it back yesterday. I moved it to savings and we will use it to pay tuition for the next semester in January.

My question is, will we be hit with taxes or penalties in any way since we technically took out "too much" and it didn't all (technically) go towards tuition in 2020? We do have a rudimentary emailed receipt from the university for the original amount paid. Will that be enough proof? This was a situation we did not anticipate, so we really couldn't have done anything differently.

Is there anything we need to do here?

 

[MarcIsMe]

Presuming you are outside the 60 day rollover window to put the excess distribution back into a 529, the funds need to be used for qualified education expenses in the same calendar year as the distribution. The simple solution would be to prepay your 2021 bill in December. The problem with trying to “fudge” it will be the 1098T coming from the university and the 1099Q from the 529 trustee. If the 1098T shows the correct tuition then you have the potential of proving what the excess was used for. If you do your own taxes also be aware of the reductions you need to take if you claim the American Opportunity Credit or the Lifetime Learning Credit. If you are uncomfortable with the issues involved at tax time, use a preparer who will stand behind their work.

 

[DLgal]

Presuming you are outside the 60 day rollover window to put the excess distribution back into a 529, the funds need to be used for qualified education expenses in the same calendar year as the distribution. The simple solution would be to prepay your 2021 bill in December. The problem with trying to “fudge” it will be the 1098T coming from the university and the 1099Q from the 529 trustee. If the 1098T shows the correct tuition then you have the potential of proving what the excess was used for. If you do your own taxes also be aware of the reductions you need to take if you claim the American Opportunity Credit or the Lifetime Learning Credit. If you are uncomfortable with the issues involved at tax time, use a preparer who will stand behind their work.

Wait, we can put the excess back? We are still inside 60 days. We withdrew the funds Aug 21.

I don't think prepaying is an option. The second semester won't start until late January. Plus, it probably still won't cost the full refunded amount.

ETA: it appears you cannot replace accidentally withdrawn funds and we will have to take the tax hit on the earnings portion of the money we withdrew. Darn. Oh well, it is only a small amount, thankfully.

 

[DLgal]

He did buy a new laptop. We can claim that, right?

 

[Eureka]

He did buy a new laptop. We can claim that, right?

Yes, computers count as school expenses and would be qualified.

 

[MarcIsMe]

Laptop is good. The rollover would have to be into another 529. Your kids would probably be ruled out since you had transferred their assets within the prior 12 calendar months. Perhaps you can open one in you name? You are trying to avoid the tax and 10% penalty.

 

[DLgal]

Laptop is good. The rollover would have to be into another 529. Your kids would probably be ruled out since you had transferred their assets within the prior 12 calendar months. Perhaps you can open one in you name? You are trying to avoid the tax and 10% penalty.

Just found this. So I guess it CAN be done?

https://www.savingforcollege.com/ar... a college issues a,tax penalty on the refund.

 

[MarcIsMe]

“The PATH Act change added a special rule for a beneficiary of a 529 plan, usually a student, who receives a refund of tuition or other qualified education expenses. This can occur when a student drops a class mid-semester. If the beneficiary recontributes the refund to any of his or her 529 plans within 60 days, the refund is tax-free.”

This is taken straight from IRS.gov

 

[DLgal]

“The PATH Act change added a special rule for a beneficiary of a 529 plan, usually a student, who receives a refund of tuition or other qualified education expenses. This can occur when a student drops a class mid-semester. If the beneficiary recontributes the refund to any of his or her 529 plans within 60 days, the refund is tax-free.”

This is taken straight from IRS.gov

Yes, that is what I saw. I guess the first article I read was out of date. I'm glad we have this option. I set up a transfer back to the 529 for Friday.

 

[crisi]

You can also use withdrawals to cover living expenses. Including expenses if they are living at home.

 

[DLgal]

You can also use withdrawals to cover living expenses. Including expenses if they are living at home.

LOL. Yeah, my husband is living at home. Can I include our $3300/month rent?

Kidding.

 

[disfanforlife]

You can also use withdrawals to cover living expenses. Including expenses if they are living at home.

I didn’t know this. What kind of living expense are allowable? My daughter lives at home and is in college.

 

[crisi]

You can take the schools room and board number and take an amount based off that. I can't find hard rules for the IRS (and you aren't going to have grocery receipts that are meaningful to calculate expenses). The notes I can find say that the IRS doesn't expect you to spend as much if they live at home vs the room and board costs (and if they live off campus, you are limited to the room and board costs under cost of attendance on the schools financial page, so I'd take a reasonable percentage - say half? (Transportation expenses are specifically excluded, however).

 

[disfanforlife]

You can take the schools room and board number and take an amount based off that. I can't find hard rules for the IRS (and you aren't going to have grocery receipts that are meaningful to calculate expenses). The notes I can find say that the IRS doesn't expect you to spend as much if they live at home vs the room and board costs (and if they live off campus, you are limited to the room and board costs under cost of attendance on the schools financial page, so I'd take a reasonable percentage - say half? (Transportation expenses are specifically excluded, however).

Thank you! This is her last semester. Wish I had thought of it sooner! I am going to do that. Plus for our son we are in a similar situation as the OP but for different reasons. He was living in the dorm and it was closed last March due to the virus so we got a refund this summer for partial room and board. I think I will calculate half of that amount as legitimate living expense. The refund was already spent on paying his tuition and rent for this semester that just started, but I have not taken any money out of his 529 for this semester yet as I was waiting to figure out calculating all of his expenses for the semester.

 

[crisi]

I did a little more reading. Calling your school should give you an official "cost of living at home" number you can use.

 

[disfanforlife]

I did a little more reading. Calling your school should give you an official "cost of living at home" number you can use.

Thank you. I am going to call. I could use 529 money for two semesters and last spring and this fall (both 2020) for "cost of living at home" for my daughter.

 

[DLgal]

You can also use withdrawals to cover living expenses. Including expenses if they are living at home.

This doesn't work for fully online programs though, I don't think.

 

[disfanforlife]

This doesn't work for fully online programs though, I don't think.

Ah ok, well this semester she is student teaching. But it is online - so that may not work for her after all. Last Spring she did have some classes in person and some online. That is what the grad program is like even before all of this.

 

[AlohaNow]

You can also use withdrawals to cover living expenses. Including expenses if they are living at home.

I would urge anyone to refer to IRS Pub. 970 before pulling money out of a 529 for 'living expenses'.