Distribution from IRA to pay for higher education expenses

[Hamacher]

I have a client that took out $40,000 out of his IRA that he said was used to pay for higher education expenses for his Wife and Child. I know that qualifying expenses include tuition, fees, books, supplies, equipment, and room and board but was wondering if it only includes out of pocket expenses and whether it only applies to expenses incurred in the current year. According to the 1098 the total amounts billed for qualified tuition and related expenses were $20,000. It also shows $15,000 was received from scholarships and grants. Does this mean that only $5,000 would be deemed qualified expenses? What if he paid for expenses that occurred in prior year (loans, etc.)? Do they qualify?

Thanks in advance for your assistance.

[KBTS]

The first thing your client needs to do is to get an actual statement from the student accounts office showing all the charges and payments made on his account from 2012. The 1098 is generally worthless, especially in a situation like this where you are looking to avoid the 10% penalty. You will need to reduce any amounts paid by the scholarships and come up with a net education expense. See TTB page 12-8 for details.

[Jesse]

Agree with KBTS, and it only applies to expenses incurred in the current year.

[FEDUKE404]

Withdrawing IRA funds for education dilemma

I have a client that took out $40,000 out of his IRA that he said was used to pay for higher education expenses for his Wife and Child. I know that qualifying expenses include tuition, fees, books, supplies, equipment, and room and board but was wondering if it only includes out of pocket expenses and whether it only applies to expenses incurred in the current year. According to the 1098 the total amounts billed for qualified tuition and related expenses were $20,000. It also shows $15,000 was received from scholarships and grants. Does this mean that only $5,000 would be deemed qualified expenses? What if he paid for expenses that occurred in prior year (loans, etc.)? Do they qualify?

Thanks in advance for your assistance.

Agree with KBTS and Jesse.

Without going into research mode at the present time, it is my recollection that you are dealing only with "qualifying expenses" and only for those incurred/PAID in the year of IRA withdrawal. The Form(s) 1098-T should assist you, to a limited degree, with finding those numbers.

I am not aware of any tax reductions you get for room and board expenses.

I hope your client is aware the only "break" he gets by calling his IRA withdrawal for education is the removal of the 10% penalty. He STILL gets burned on the regular income on the amount withdrawn. Depending on his tax bracket, that could have been a very expensive decision.

Oh yes - be sure he is talking around IRA....and not 401(k) or similar.

FE

[Roland Slugg]

I am not aware of any tax reductions you get for room and board expenses.

If the student is at least a half-time student, reasonable amounts paid for room and board do qualify for this purpose ... i.e. avoiding the 10% penalty for early withdrawal from an IRA. (Code §72(t)(2)(E), §72(t)(7) and 529(e)(3)(B)(i))

[BP.]

not aware of any tax reductions you get for room and board expenses.

See TTB page 12-8 for details.

http://www.irs.gov/publications/p970/ch09.html

See KTBS`s TTB reference, or Pub 970, for qualifying expenses for 10% penalty waiver. I've had a number of clients who've used education expenses as a waiver and then had to provide proof, so I let people know they should have good records not just of the tuition, books, etc, but records that show the qualifying room & board expenses, esp. if off campus.

[FEDUKE404]

IRA withdrawals for room & board

If the student is at least a half-time student, reasonable amounts paid for room and board do qualify for this purpose ... i.e. avoiding the 10% penalty for early withdrawal from an IRA. (Code §72(t)(2)(E), §72(t)(7) and 529(e)(3)(B)(i))

Learn something new every day. Thanks for steering me onto the correct path.

I guess I've never been exposed to such a scenario...regardless of dodging only the 10% penalty bullet, that still sounds like a very costly way (tax-wise) to pay for a college education, especially since the client apparently also received a large part of his "college expenses" as grants, which I assume must offset something, somewhere, in this discussion.

FWIW: I'm still a bit intrigued by the OP with higher education expenses for both the wife and child. Wife is >50% student? Lives in parental home?

This client and I would probably need to have a very extended conversation before I would sign off on the tax return as so far presented.

FE

[Roland Slugg]

The main question posed in the OP was whether or not education expenses incurred and/or paid in other years qualify for the waiver of the 10% penalty for an early distribution from an IRA in the current year. Code §72(t)(2)(E) says that the waiver of the 10% penalty on an early distribution from an IRA applies to "distributions to an individual from an individual retirement plan to the extent such distributions do not exceed the qualified higher education expenses [] of the taxpayer for the taxable year." That seems to make it pretty clear that qualifying expenses for purposes of this exception would only be those incurred and paid during the year.

I'd also like to add a few additional points and references related to this issue:

The expenses can be for the taxpayer, his spouse, his child or his grandchild. (Code §72(t)(7)(A))

Except for room and board to qualify, the student doesn't need to be a "half-time" or better student.

The IRA distribution does NOT actually have to be used, or even needed, to pay for the education expenses. No "tracing" is required. The expenses can be paid for with any funds the taxpayer has, including funds received from a loan, a gift or inheritance. Expenses paid with non-taxable scholarships or grants, however, do not count in the "expenses paid" total.

Some have suggested that the taxpayer needs to secure form(s) 1098-T. While those forms may be helpful, they are not really necessary. The taxpayer just needs to consult his own financial records, such as paid bills and canceled checks, to come up with the total paid.

[New York Enrolled Agent]

The main question posed in the OP was whether or not education expenses incurred and/or paid in other years qualify for the waiver of the 10% penalty for an early distribution from an IRA in the current year. Code §72(t)(2)(E) says that the waiver of the 10% penalty on an early distribution from an IRA applies to "distributions to an individual from an individual retirement plan to the extent such distributions do not exceed the qualified higher education expenses [] of the taxpayer for the taxable year." That seems to make it pretty clear that qualifying expenses for purposes of this exception would only be those incurred and paid during the year.

The Tax Court agrees with Roland's interpretation of the Code. The holding in TCM 2005-162

Held: Sec. 72(t)(2)(E), I.R.C., does not allow P to escape the additional tax of sec. 72(t)(1), I.R.C., ...

sec. 72(t)(2)(E), I.R.C., requires that qualified higher education expenses be for the taxable year of the distribution.

[LCP]

Since off campus housing costs do qualify as long as they don't exceed the schools "cost of attndance" then no costs would qualify if a student is attending a commuter school where there is no on-campus housing. Agreed??

[DexEA]

Since off campus housing costs do qualify as long as they don't exceed the schools "cost of attndance" then no costs would qualify if a student is attending a commuter school where there is no on-campus housing. Agreed??

I disagree, however not 100% sure I am correct. I believe each school has an amount, or allowance, that is figured into the financial aid calculation and this is the number you need to obtain from the school. If you call the school financial aid office they should know exactly what you are asking.

The expense for room and board qualifies only to the extent that it is not more than the greater of the following two amounts.

1. The allowance for room and board, as determined by the eligible educational institution, that was included in the cost of attendance (for federal financial aid purposes) for a particular academic period and living arrangement of the student.

2. The actual amount charged if the student is residing in housing owned or operated by the eligible educational institution.