Reporting 529 Plan Withdrawals on Your Federal Tax Return

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Kathryn Flynn

By Kathryn Flynn

December 18, 2023

When you use 529 plan funds to pay for qualified education expenses, there is usually nothing to report on your federal income tax return. Form 1099-Q and Form 1098-T will list the amount of the 529 plan distribution and how much you used to pay for college tuition and fees, but it is up to you, the 529 plan account owner, to calculate the taxable portion.

What is IRS Form 1099-Q?

IRS Form 1099-Q is a statement issued by a 529 plan or Coverdell ESA administrator that lists the amount of distributions in a given tax year. The Form 1099-Q will be issued to the beneficiary if the 529 distribution was paid to:

  • The 529 plan beneficiary
  • The college, K-12 school, or apprenticeship program the beneficiary attends
  • A student loan provider

When the Form 1099-Q is issued to the 529 plan beneficiary, any taxable amount of the distribution will be reported on the designated beneficiary’s income tax return. This typically results in a lower tax obligation than if the Form 1099-Q is issued to the parent or 529 plan account owner.

Form 1099-Q lists the total distributions from a 529 plan or Coverdell ESA during a given calendar year, regardless of how the beneficiary or account owner spent the funds. Typically, Box 1 of Form 1099-Q lists the total distribution, Box 2 includes the earnings portion of the distribution, and Box 3 includes the basis, which is the contribution portion of the distribution.

The earnings portion of a non-qualified withdrawal is subject to income tax and a 10% penalty.

What is IRS Form 1098-T?

IRS Form 1098-T is a statement issued by a college or other eligible post-secondary education institution that lists the amount a student paid in tuition, fees required for enrollment, or course materials required. Form 1098-T determines whether or not the student qualifies for federal education tax credits, such as the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Tax Credit (LLTC).

Form 1098-T can be misleading because it does not provide a complete list of 529 plan qualified expenses. For example, Form 1098-T does not include room and board costs, computers and internet access, K-12 tuition, student loan repayments, or costs of apprenticeship programs. It’s up to the beneficiary and their parents to save receipts and calculate the total amount of qualifying 529 plan expenses during the tax year.

How to calculate 529 plan taxable distributions

529 plan distributions used to pay for non-qualified expenses are subject to income tax and a 10% penalty on the earnings portion of the withdrawal. This includes 529 distributions for airfare and other travel costs, college application or testing fees, health insurance, or room and board costs beyond the college’s cost of attendance (COA) allowance. 

If the student’s parent qualifies for the AOTC or LLTC, they must adjust their total qualified higher education expenses to avoid double-dipping. To determine the amount of a qualified 529 plan distribution, you must subtract any amount used to generate the federal education tax credit from the total qualified expenses.

Suppose the beneficiary receives a tax-free scholarship, fellowship grant, Veteran’s educational assistance, employer-provided assistance, or other tax-free educational assistance. In that case, the payment amount must also be subtracted from the total qualified expenses. 

For example, parents who claim the AOTC and spend $10,000 on qualified higher education expenses in a given tax year may withdraw $6,000 from a 529 plan without tax consequences:

$10,000 – $4,000 (used to generate the AOTC) = $6,000 Adjusted Qualified Education Expenses (AQEE) 

If the student receives a $2,000 tax-free scholarship, the AQEE for the student in this example is reduced further to $4,000.

Exceptions to the 10% penalty

When the total 529 plan distribution exceeds the AQEE, the excess amount will be subject to income tax on the earnings portion of the withdrawal. However, the 10% penalty is waived when the non-qualified distribution occurs due to the tax credit adjustment up to the amount of the qualified expenses that justified the tax credit. 

Similar exceptions to the 10% tax penalty apply when the beneficiary receives a tax-free scholarship, veterans’ educational assistance, employer-paid educational assistance, and other tax-free educational assistance (other than gifts or inheritances). As with the AOTC and LLTC, the tax penalty is waived only to the extent of the qualified expenses that justified the tax-free educational assistance.

There are exceptions when the beneficiary dies, is disabled, or attends a U.S. military academy.

How to report a taxable 529 plan distribution on federal income tax returns

The earnings portion of a taxable 529 plan distribution must be reported on the beneficiary’s or the 529 plan account owner’s tax returns. To calculate the taxable portion of the 529 plan distribution:

  • Divide the AQEE by the total 529 plan distribution (Form 1099-Q, Box 1)
  • Multiply the answer by the earnings portion of the total distribution (Form 1099-Q, Box 2).
  • Subtract this amount from the total distributed earnings

The result must be reported as income on the beneficiary’s or the account owner’s federal income tax return, Schedule 1 Form 1040, line 8, or Form 1040NR, line 21. If the distribution is subject to the 10% penalty tax, the additional tax must be reported on Schedule 2 (Form 1040), line 6, or Form 1040NR, line 57.

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