Question

Z is a dependent beneficiary of a 529 savings plan established by her paretns. During the current year, Z received a $20,000 distribution and used it to pay $20,000 for tuition at a private university. Z’s parents contributed $60,000 to the plan and earnings from investments total an additional $20,000.

1. How much of the $20,000 distribution may Z exclude from gross income?
2. Assume Z elects to join the work force rather than attend college and the entire $80,000 accumulated in the plan in distributed to Z’s parents. How much is included in the parent’s gross income?

Answer 1

,As per 529 plan, Distributions are tax-free if it is used to pay qualified higher education expenses. And tution fees are treated as qualified higher education expenses.

Solution 1)  $20,000 distribution may Z exclude from gross income as full $20000 is used for qualified education expenses. However tution for K-12 schools has maximum withrawal limit of $10,000 per year. Assuming that this tution fees not covered in k-12 schools fees. Hence limit not apply. And full $20000 withdrawal is tax free. And not added to gross income of beneficiary.

Solution 2) Assume Z elects to join the work force rather than attend college and the entire $80,000 accumulated in the plan in distributed to Z’s parents. In $80000 distribution, some part is from earning while other is from contribution. Earning portion of this distribution will be taxed and included in the parent’s gross income and some penalty also will be charged. But portion of this distribution which comes from contribution will not be taxed. Hence, $20000 will be added in gross income of parent.

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