Taxable Education Distribution?

[hjltax]

Taxpayer's daughter entered college in the Fall semester and was billed for Fall and Spring of following year. Taxpayer received an ESA distribution in Fall for the entire bill and paid it in that Fall.

On that first year's tax return, is anything taxable (never mind earnings on the account)? In other words, for computing taxable distributions, are following year's first three months' expenses deemed qualified education expenses for the period in which it was paid?

Thanks for your help.

[mactoolsix]

https://www.irs.gov/individuals/qualified-ed-expenses

Academic Period

You must pay the qualified education expenses for an academic period that starts during the tax year or the first three months of the next tax year. Academic periods can be semesters, trimesters, quarters or any other period of study such as a summer school session. Academic periods are determined by the school. For schools that use clock or credit hours and do not have academic terms, the payment period may be treated as an academic period.

[FEDUKE404]

Dealing with education credits and expenses

This topic has been beaten into the ground on these boards. Suggest you do a couple of searches for answers to your questions.

Simple answer: You track the allowable "qualifying" expenses, as shown on the Form 1098-T, **AND** when they were paid. "Billed" is essentially irrelevant.

From your example, there is likely no taxable income.

It goes without saying that, to properly prepare the tax return, you should have a Form 1098-T in hand and probably a Form 1099-Q for the distribution. Of course, you will have to endure Form 8863 and the due diligence questions on Form 8867.

FE

[hjltax]

Thanks to you both. I knew the three-month rule with respect to Education Credits, however, everything I read did not really indicate that rule also applied to distributions from education accounts.

[Rapid Robert]

Thanks to you both. I knew the three-month rule with respect to Education Credits, however, everything I read did not really indicate that rule also applied to distributions from education accounts.

Like you, I don't think the "first 3 months of following year" rule applies to ESAs. Pub 970 only mentions expenses for the current year.

§530(d)(2)(A) - "No amount shall be includible in gross income under paragraph (1) if the qualified education expenses of the designated beneficiary during the taxable year are not less than the aggregate distributions during the taxable year."

If anyone can find where the extra 3 months is included, please provide a cite.

I had a new client once with a QTP (which is vastly more flexible than an ESA, probably why I've never seen an ESA in real life) and had to break the bad news that taking money out in December to pay next year's tuition bill was not a good idea.

[FEDUKE404]

Dealing with education fund withdrawals

I didn't realize the sticking point here was the timing of ESA withdrawals (I repeat the need to locate a Form 1099-Q !!).

For most of my clients, as well as my offspring, the "common" practice (certainly for the "state schools") is to pay the bulk of the spring semester college bill prior to the end of the preceding calendar year. In reality, even though you still have to deal with "billed" qualifying expenses as shown on the Form 1098-T, the number-matching is simpler once you also have a bursar statement or similar.

I never thought for one moment that taking an ESA withdrawal near the end of a calendar year to use for payment of the spring semester fees in the next calendar year would create any kind of tax problem. I see things as making an ESA withdrawal to pay for qualifying, current-year expenses. . .end of story. Perhaps I've been in the dark?

It needs to be noted that the primary hurdle for the ESA withdrawal is to "prove" there were sufficient allowable expenses (which differ significantly from those used for education credits) so as not to create taxable income for the beneficiary. Did I mention Form 1099-Q? You are not subject to tax on the amount withdrawn, but rather to tax on the "earnings" shown. Most people will see any potential taxable income evaporate, although to a certain degree you first do have to "prove your innocence." (Not unlike knocking down a generous scholarship that pays more than "qualifying" expenses.)

FWIW: There also are options to avoid said tax/penalty if certain very specific guidelines are met. The administrator also has the option of allowing "corrective actions" ( = repay ) but those rules are tight.

I have seen some excellent worksheets to handle this type of situation. TurboTax (bless their heart!) has the best with multi-columns for each situation, use as education credits, 529 plans, ESA, etc. STRONGLY suggest you go through the Q&A and don't try to plug in your own numbers! Also TaxACT has a similar worksheet, but a bit more confusing.

I'll keep an eye on this thread to see what I can learn.

FE

[mactoolsix]

Thanks to you both. I knew the three-month rule with respect to Education Credits, however, everything I read did not really indicate that rule also applied to distributions from education accounts.

I must agree with Robert on this - I didn't realize the ESA accounts require expenses be in the same year.

I also found this https://www.ameriprise.com/content/files/AMP_24044.PDF (pg 19):
Generally, amounts distributed from a Coverdell Education Savings Account are not
includible in the designated beneficiary’s income if the total amount
distributed from the Coverdell Education Savings Account is less than or
equal to the designated beneficiary’s qualified education expenses for the
same year, . . . . .

Mike