You’ve got questions, we’ve got answers. During our webinar about the Impact of Coronavirus on Paying for College, participants asked dozens of questions. Here are the answers to these questions on 529 college savings plan and COVID-19.
Say a parent takes a $10,000 distribution from a 529 plan, paid directly to then university, then the university refunds $1,500 because the student had to move out of dorm and couldn’t use the meal plan due to coronavirus. If the client keeps funds, it is still a distribution? Would it be subject to penalty? So, should they send back the money as a rollover contribution?
If a 529 plan distribution was used to pay for qualified higher education expenses and the university subsequently refunds some of those expenses, the distribution may become non-qualified to the extent that it exceeds the remaining qualified expenses.
A non-qualified distribution is subject to income taxes and a 10% tax penalty on the earnings portion of the distribution, plus possible recapture of any state income tax breaks attributable to the distribution.
There are two potential workarounds that can avoid the taxes and penalties on a non-qualified distribution.
One is to find other qualified education expenses to justify the qualified distribution. For example, if the college is delivering the classes through online education, the student might need to buy a computer, peripherals and internet access. The cost of a computer is a qualified higher education expense.
The other is to recontribute the money to a 529 plan for the same beneficiary within 60 days of receipt of the refund. The money does not need to be recontributed to the same 529 plan. The refund must be from the college or university, not an independent organization.
If you wait until after 60 days have passed to return the money to a 529 plan, the money will count as a new contribution and not a recontribution.
What if I received a refund from my son’s college, but instead of contributing it back to the 529 plan, I just use it towards next semester’s tuition/room/board. Is that reasonable?
To be considered a qualified distribution, the distribution needs to be made in the same tax year as the qualified expenses. If you receive a refund in the spring and use it in the fall, the expense and distribution are both within the same tax year if you use a calendar year accounting period. If you are a fiscal year tax filer, however, using the refund in the fall may cause part of the distribution to become non-qualified if your tax year ends between the spring and fall.
The qualified expenses must be paid in the same tax year. If you use the refund to pay for qualified expenses in 2021, the 2020 distribution will not be considered qualified. However, if you pay for 2021 college costs in 2020, the 2020 distribution will be a qualified distribution.