coverdell IRA funds for prior year tuition

[EllieB]

Client (call him grandpa) owns a coverdell IRA for his grandson (now age 14). Grandson still owes private school tuition for 2011 - debt has been turned over to collection agency. Can Grandpa use coverdell IRA funds to pay off 2011 tuition?

[mastertaxguy]

Coverdell esa--prior year private school tuition

1. Your facts do not indicate if the grandson is still in a private school. If so, a distribution used for current year tuition would be tax free. Your scenario also does not indicate anything that might make the private school tuition a possible medical deduction (special needs child for example).
2. Using the distribution to pay the 2011 tuition, in full or in part, would NOT be a qualified use of the funds and would result in income being charge to the beneficiary (grandson) assuming he got the money and then paid the school.
a. The income is the earnings attributable to the amount used to pay the 2011 tuition bill.
b. Grandpa would not be subject to tax unless he took the money out and HE paid the creditor, AND THEN ONLY ON THE EARNINGS.
c. Yes, I know it is more likely the grandson's parent are being dunned by the collection agency so any distribution probably would be turned over to the parents. If the earnings are below, say, $300.00, paying the money over to the grandson and having him give to his parents would probably eliminate any federal/state income tax (absent other possible factors not present in your scenario).
3. Paying the private school tuition, absent facts not represent in your question, would not be tax deduction for whomever paid it.
4. Grandpa would be well advised not to do anything to make it look like he is assuming the debt or becoming responsible for past, present or future obligations.
5. We all would be well advised not to give legal advice to clients or their family/grandchildren unless we are licensed attorneys in the jurisdiction.

[Roland Slugg]

First of all, a Coverdell ESA is not an IRA, although prior to 2002 they were known as "education IRAs." There is no deduction allowed for contributions going into a Coverdell ESA. Distributions are either partially tax-free, under the annuity rules, or entirely tax free ... i.e. including the earnings on the principal ... if used for qualifying education expenses.

The expenses described in the OP certainly appear to be qualifying ones, unless there is a requirement that distributions must be used to pay for current year's expenses. In the limited reading I did before replying, I could find no such requirement.

Even if the distribution is partly taxable, the income portion can't be very much ... can it?

For further research, see Code §530.

Added comment: I have never had a client use a Coverdell ESA, so I have the impression they have been sparsely used nationally. The Coverdell ESA has a $2,000 annual contribution limit, and there is a phase-out when the contributor's income exceeds certain amounts (depending on filing status). By comparison, "Qualified Tuition Programs" (529 plans) have neither an income limitation nor a contribution limitation. There are a few differences between Coverdell ESAs and QTPs ... most notably that a Coverdell ESA can be used for primary education, not just secondary education ... but IMO a 529 plan is a far better way to fund a child's higher education.

[zeros]

Distribution of Coverdell ESA - 1st One Ever

Working on one of these where the client received a 1099Q. $11K (final) distribution where clients says his contribution is about $8K. Can't believe he made that much. I told him to verify the contribution from where he contributed. Never heard back. Also, I believe the board and room are also figured in the calculation and inquired about that amount. Never heard back. Is this information difficult to verify? I had heard that IRS does not always follow-up on these as the end result does not come out to be much additional taxable income. Agree?