1099Q for Coverdell ESA Distribution

[Steve Stang]

I have a tax client who is married filing jointly. He has a son (high school grad) who was planning to enroll in college but somehow this didn't happen in 2013. The client (the kid's father) took several distributions from a Coverdell ESA (total $2,000+/-). He was informed by the account broker that "the money wasn't taxable as long as it is used for college items and he said to hold on to any receipts in case I get questioned or audited about the money. Since XXXXX hasn't gone to school he still has the money set aside for college items." So the taxpayer client thinks that this money doesn't have to be reported or taxed.

This client also has several IRA accounts (managed by me) from which he's taken several thousand dollars of early distributions - all taxable and penalized. In this case, I've disclosed that he owes taxes, we withheld to account for it and I knew to expect the 1099Rs. This 1099Q was a real surprise to me - as these folks never disclosed the accounts to me (not for tax compliance but for my investment advisory compliance).

So I've tried to tell him that this is just like his IRA distributions: You can't try to match these distributions with some future expenses. Like the IRA, you have to pay the taxman his pound of flesh now even if the amount taken out will be used for retirement (for IRAs) or ESA and 529 plans (for education).

Am I wrong? I don't think I am. I think I have to count the distribution and the best that I can do is minimize the tax by calculating the tax on the gain only.

If I'm not then I believe that I need to document the 12/2013 account value and figure out the capital gains to figure out the taxes due.

I taking my cues from TB 12-6 about the taxes due and computation.

[veritas]

The expenses

need not be just for higher ed. K through 12 expenses qualify as well.

Was there earnings in the distribution?

See page 12-5 to 6 in TTB.

[mactoolsix]

Yes, only the distributed gain is taxable.

From Pub 970 Ch 7 http://www.irs.gov/publications/p970...link1000178471
The taxable portion is the amount of the excess distribution that represents earnings that have accumulated tax free in the account.

The pub provides a 4 step calculation.

The account broker was correct, except he forgot the part about which year to use the funds.

Mike

[Steve Stang]

need not be just for higher ed. K through 12 expenses qualify as well.

Was there earnings in the distribution?

See page 12-5 to 6 in TTB.

Thanks. In this case, the client's son had already graduated from high school before the distribution. I was looking to get him to give me some idea of expenses for high school but a no go.

And I can't tell if there are any earnings since the broker can't talk to me without permission of the client, the client had provided no statements and the 1099Q has no cost basis information - and when I called the fund administrator they said "well, it's not something we report since an ESA is not taxable." Partially correct on his end. Usually not taxable but not in this case.

[Steve Stang]

Yes, only the distributed gain is taxable.

From Pub 970 Ch 7 http://www.irs.gov/publications/p970...link1000178471
The taxable portion is the amount of the excess distribution that represents earnings that have accumulated tax free in the account.

The pub provides a 4 step calculation.

The account broker was correct, except he forgot the part about which year to use the funds.

Mike

Thanks. That's exactly what I thought. But unfortunately the broker probably knows only enough to be dangerous and the client only heard what he wanted to hear.

Since I have no information, I'm using a plug figure for now until I do get something. I'm assuming the worst case scenario that the basis is $1 and the whole thing is gain. That way you can't get in trouble with the IRS for under-reporting income. And the client can see the impact on his income and reduced refund which may motivate him to either get me the information or give me permission to speak with the broker.


This all could have been avoided if he didn't confuse his finances by bringing in another financial advisor besides me - end of my kvetch on that point.