Tuition Deduction / Paid with 529 principal funds not earnings??

[bbrownatl]

So, my client gets a 1098-T indicating the tuition paid. He indicates that it was paid with 529 funds. My understanding is that he can't take the tuition and fees deduction given that it was paid with "tax-favored" funds which I agree with regarding the earnings. However, just wondering if part of the tuition payment tapped into the original principal of the money contributed to the 529, wouldn't that be deductible via the tuition and fees deduction?

Any insight appreciated.

Much thanks.

[BP.]

My understanding is that he can't take the tuition and fees deduction given that it was paid with "tax-favored" funds which I agree with regarding the earnings. However, just wondering if part of the tuition payment tapped into the original principal of the money contributed to the 529, wouldn't that be deductible via the tuition and fees deduction?

See Pub 970, especially pp. 58-60, to coordinate 529 withdrawals and tax benefits. There are formulas there you can plug your numbers into. Also TTB 12-6 & 7.

FIRST, the T&F deduction can be fully claimed on the qualifying amount paid, THEN, figure any taxable part of the earnings from the 529 distribution.

[Roland Slugg]

Distributions from a QTP (i.e. a 529 plan) ... both contributions and earnings ... are tax-free as long as they are used for qualifying educational costs and expenses. The references to "tax-free educational assistance" in Pub 970 and the instructions to F-8863 are referring to scholarships, Pell grants and veterans assistance, NOT to qualified distributions from a QTP (or a Coverdell ESA). As long as the distributions from the QTP plus any tax-free assistance are equal to or less than the education costs, there will be no taxable income. Even if they do exceed the qualifying educational costs, taxable income can still be avoided by properly allocating the various proceeds to the proper categories of expenses ... tuition, books, room and board.

Is the T&F deduction the most advantageous option for your client? The AOC or LLC will usually provide the greater benefit.

[BP.]

As long as the distributions from the QTP plus any tax-free assistance are equal to or less than the education costs, there will be no taxable income.

And remember to put the word "adjusted" into the above sentence before the phrase "education costs," because that "adjusting" step includes taking whichever qualified tuition tax benefit is available. And then compare with the 529 distribution.

[Snaggletooth]

Smart-Aleck Comment

Does not apply to the original question, but you have to wonder about the financial institutions that sell these plans. IOW, not enough earnings after years of funding to pay without invading the principal. Of course if the student is going to a high-cost tuition school the whopping cost might be the problem as opposed to wimpy earnings.

In most cases, I advise opening an UGMA in the child's name and social security number. There have to be substantial earnings before the child would have to file a return, and then there are no stipulations on the funds when the child comes of age. I've seen 529 funds where the custodian makes more money in fees than the fund will earn in 15 years.

[FEDUKE404]

Children with taxable income

. . . There have to be substantial earnings before the child would have to file a return, and then there are no stipulations on the funds when the child comes of age. . .

Not sure of your definition of "substantial" but the infamous kiddie tax (Form 8615) can enter into play to disrupt those long-term plans.

My children were filing tax returns, while they were still in diapers, due to UGMA income.

FE

[Roland Slugg]

Are QTPs (529 plans) sold by financial institutions? They are all sponsored by the various states or state agencies, and I'm sure each one has rules and regs regarding where and how the funds are invested. You are right, though ... there are gonna be fees that reduce earnings.

But where, pray tell, did you get the idea that 529 plans were designed so that the earnings on the saved funds would cover the cost of college? I doubt if that happens, or is even intended to happen, in one case out of 1,000. Instead, they are meant to work more like an annuity. Invest $5,000 per year for, say, 12 years, then, hopefully, there will be enough to withdraw $20,000 per year to pay for 4 years of college, consuming all the principal and earnings thereon.

There are two different types of QTPs: Pre-paid tuition plans and college savings plans. I like the concept of the PPT plans, but they come with so many restrictions and limitations that they probably won't work for many families and students. "But dad, I don't want to go to the local college. I want to go to Xxxxx" ... in another state, of course.

Smart-Aleck Comment

Didn't even notice a S-A-C. But even if there was one there someplace, I'd rather read one of those than the political rants you used to post here all the time.