Who Pays Taxes on Non-Qualified 529 Plan Withdrawal?

Qualified withdrawals for a 529 plan are generally tax-free. But what happens if you withdraw 529 plan funds for something other than qualified education expenses?

If you take a non-qualified distribution from a 529 plan, whose tax rate applies? The recipient of the non-qualified distribution pays the taxes on the distribution.

For example, if a parent takes a non-qualified distribution from the 529 plan to pay for travel costs, the parent will pay the taxes if the check from the 529 plan is in the parent’s name.

Withdrawals from a 529 plan may be paid directly to the educational institution, the beneficiary, or the account owner.

The account owner or the account beneficiary will have to pay federal income tax on the earnings portion of a non-qualified withdrawal plus a 10% tax penalty. The person responsible for reporting the non-qualified distribution on their income tax returns depends on the recipient of the taxable withdrawal, as shown in this chart.

This is because the Internal Revenue Code of 1986 requires non-qualified distributions to be included in the distributee’s gross income. [26 USC 529(c)(3)(A)]

The recipient listed on the 1099-Q must report the taxable earnings portion on their tax return. The instructions for IRS Form 1099-Q state:

QTP. List the designated beneficiary as the recipient only if
the distribution is made (a) directly to the designated
beneficiary, or (b) to an eligible educational institution for the
benefit of the designated beneficiary. Otherwise, list the
account owner as the recipient of the distribution. Enter the
TIN for the applicable recipient.

This means the parent will handle the taxes if the parent is listed as the recipient on the form. Similarly, if the beneficiary receives the distribution, they are responsible for reporting it.

This contrasts with a Coverdell Education Savings Account, where the beneficiary is considered the recipient of all withdrawals.