Due to COVID-19, numerous schools throughout the country have been shut-down or have moved their classes and programs to online-learning. As a result, colleges and universities are issuing partial refunds to students for this semester's tuition and room and board. If the original tuition and room and board was paid for utilizing withdrawals from a 529 plan, this could lead to a potential tax risk for the owner of the plan.
What is the tax risk of receiving a refund for tuition and room and board that was paid for with 529 withdrawals?
As many students or their parents are receiving refunds for a portion of their tuition and room and board, the amounts paid for using 529 withdrawals are no longer being utilized for qualified educational expenses. Due to this, the IRS could re-characterize those withdrawals as taxable distributions. Withdrawals not utilized for qualified education expenses are subject to a 10% penalty, as well as, tax on the earnings portion of the distribution.
How do I avoid the penalties and tax on the 529 distribution?
In order to avoid the 10% penalty and the tax on the earnings of the distribution, the 529 account owner has two options. The account owner can utilize the 529 withdrawals funds to pay for qualified higher education expenses (QHEEs) in the same year as the withdrawal or by March 31st of the following year. If the withdrawal will not be used for QHEEs in the specified time-frame, the account owner must recontribute the refunded amounts to their 529 accounts within 60 days from the date the refund was issued.
What qualifies as qualified higher education expenses?
Tuition, fees, books, supplies and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution are considered qualified higher education expenses. In addition, expenses for the purchase of computer or equipment, computer software, or Internet access and related services, if such equipment, software, or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution. In addition, the Tax Cuts and Jobs Act changed federal law for QHEEs to include tuition at an elementary or secondary (k-12) public, private or religious school the beneficiary is enrolled at. Please note that the State of Nebraska has not coupled with changes to the federal law under the Tax Cuts and Jobs Act.
How much do I have to recontribute to the 529 plan if I'm recontributing?
You are only required to recontribute the portion of the refund paid for using 529 plan withdrawals.
What steps are needed to recontribute amounts to a 529 plan?
Most 529 plan providers will require a variation of the following steps:
Retain documentation stating the date and the amount of the refund received from the institution.
When submitting the re-contribution, you should include a letter detailing the information surrounding the re-contribution. The letter should include the amount you are recontributing, statement indicating the payment should be characterized as a re-contribution of a previous qualified withdrawal, proof that you are making the payment within 60 days of receiving the refund, account number and name of the student beneficiary, and the original date and amount of the qualified withdrawal.
The 529 account owner should send a check for the amount to be recontributed. It is recommended the check indicate in the memo the payment is for a "529 plan re-contribution of 2020 school refund amount". Send the check and letter via certified mail to document your timely re-contribution.
It is recommended that you contact your 529 plan provider to ensure all necessary information is documented and the appropriate steps are taken in regards to the re-contribution.