529 plans offer tax-sheltered growth for post-secondary education costs and tax-free distributions -- as long as you use the money for qualified costs. Qualified costs include tuition, fees, supplies and, if you're enrolled at least half-time, room and board at a post-secondary school, such as a trade or vocational school, college or graduate school. If you use the entire amount of your 529 plan distribution for qualified expenses, you don't have to report it on your income taxes. However, if any or all of it is used for non-qualifying expenses, you've got some explaining to do to Uncle Sam.
Items you will need
- IRS Form 1099-Q
- IRS Form 1040
- IRS Form 5329
Calculate the portion of the distribution that isn't qualified by dividing the portion of the distribution not used for qualifying expenses by the total distribution. For example, if you take a distribution of $10,000 and use $6,000 for qualifying expenses, divide $6,000 by $10,000 to get 0.6.
Multiply the result by the amount of earnings withdrawn to find the taxable portion of the distribution. The earnings portion of the distribution is recorded in box 2 of Form 1099-Q. Continuing the example, if $3,000 of the distribution is earnings, multiply $3,000 by 0.6 to find that $1,800 of your distribution is taxable.
Report the taxable portion of your 529 plan distribution on line 21 (miscellaneous income) of your Form 1040 tax return. This amount is included in your taxable income.
Complete Part II of IRS Form 5329 to calculate the penalty on the non-qualified distribution from your 529 plan. The penalty is 10 percent of the taxable portion of the distribution unless an exception applies. Exceptions include if you're permanently disabled or received a tax-free scholarship to pay for college costs.
Report the penalty, if any, on line 58 of Form 1040. This amount is added to your income taxes.
- You can't count qualified expenses for both your 529 plan distributions and an education tax break. For example, if you have $5,000 in qualified expenses and you use $4,000 to claim the American opportunity credit, you only have $1,000 remaining to use for your 529 plan distribution.
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