Education IRA

[NotEasy]

Taxpayer contributed $1,000 to his son's education IRA some years ago.

Last year, while his son was only 14 years old, he withdrew the full balance ($3,500). So none of it was used for qualified education expense. He received a Form 1099-Q for year 2012 with $3,500 as the distribution in box 1.

I understand the capital gain $2,500 ($3,500 - $1,000) is considered income in the tax return.

My question is: is there any penalty? And if yes, would the penalty be imposed on the full amount of distribution or just the capital gain portion of the distribution.

[Traveling EA]

Coverdell ESA

Reporting. The taxable amount is reported as Other Income, line
21, Form 1040. If any taxable amount is reported, Part II, Form
5329, Additional Taxes on Qualified Plans (Including IRAs) and Other
Tax-Favored Accounts, is required to calculate additional tax even
if an exception applies

[Roland Slugg]

Yes, a 10% penalty applies on the taxable portion of the distribution. (Code §530(d)(4)) Figure it on F-5329.

The $2,500 "profit" is not a capital gain. It is taxed as ordinary income. (Code §135(c)(2)(C)) Enter it on the "Other income" line of F-1040 ... line 21, I believe.

Finally, a terminology correction. These were once called "Education IRAs" but have been known as Coverdell Education Savings Accounts (ESAs) for several years now.