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Taxes on 529 withdrawals11/11/2023 ![]() ![]() ![]() For example, if 2018 scholarships are $10,000, AOC is $2,000, and eligible education expenses are $30,000, the maximum 529 plan reimbursement would be (30-10-2=) $18,000. Second, is there a written IRS instruction specifically addressing your conclusion as to deferred use of scholarships to avoid withdrawal penalties? I know that eligible expenses need to be matched to 529 withdrawals annually, but that doesn't specifically cover matching scholarships to unqualified withdrawals. Two questions, please.įirst, are you suggesting that if the scholarship was received freshman year, so long as the non-qualified withdrawal covered by the scholarship is made by the final year of school, it would not be subject to penalty? "You should have liquidated the account in the final year of school or transferred the left over to another qualified family member. Anyone confident of an answer either way? TurboTax does not make it easy to try to use a prior year scholarship to eliminate the 10% penalty in a post-graduation year that has no current eligible education expenses. I can find no guidance on this, despite the wisdom of a tax policy that encourages parents not to withdraw 529 plan money until they are sure that it won't be needed just because a scholarship is received in a particular year. We are talking about parents not wanting to "waste" 529 money by withdrawing it too early rather than taking advantage of penalty-free withdrawals based on scholarships AFTER there are no college costs left to be paid. Is that permissible? We're not talking about making sure that eligible expenses are counted in the proper tax year-all expenses were properly allocated. The parents withdraw it and want to avoid the 10% penalty on the taxable earnings by pointing to the freshman year scholarship and the "unused" protection against the 10% penalty from freshman year. But what if the parents, rather than withdrawing $25,000 that year, only withdrew $20,000, because they wanted to avoid depleting the 529 account before they know that all college costs had been covered? Four years later, there is left in the 529 plan $5000. But if a scholarship is received, a distribution can be made without the 10% penalty, For example, if for a student's freshman year, there is a $25,000 withdrawal is made in a year when a $10,000 scholarship was received and applied to a total of $30,000 of qualified education expenses (assume no AOC or tuition deductions), the withdrawal would have exceeded by $5000 the $20,000 of net remaining eligible expenses after scholarship, The $5000 would be taxable as to the 529 plan earnings included in the withdrawal, but there would be no 10% penalty. If a non-qualified distribution is made from a 529 plan, it is generally taxable to the extent of earnings and a 10% penalty is added. ![]()
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