Level 3

529 plan distribution and support test

Forum|Forum|6 years ago
April 20, 2020
2 replies
24 views

80% of the college tuition was paid from the 529 plan distributions. Is the distribution from 529 plan considered as a parent support or student support? Form 1099-Q and Form 1098-T are all issued under the student's name. Is any one aware of any new development in this issue? If the distribution is considered as a student support, the student paid more than half supports , so his parents cannot claim him as a dependent. He also had some earned and unearned income and will be subject to kiddie tax.

Thanks!

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itonewbie

Level 15

I suppose there are different opinions out there. I am in the camp that this is the student's own support.

Why do I say that? If I look at §529(c)(2), this is what it says (emphasis added):

529(c)(2)Gift tax treatment of contributions.—
For purposes of chapters 12 and 13 -
529(c)(2)(A)In general.—
Any contribution to a qualified tuition program on behalf of any designated beneficiary -
529(c)(2)(A)(i) shall be treated as a completed gift to such beneficiary which is not a future interest in property, and
529(c)(2)(A)(ii) shall not be treated as a qualified transfer under section 2503(e).

If these contributions are a complete gift, it is no longer the contributors' money.

Some argue that since these accounts are usually owned by the contributor and the contributor is permitted to change the designated beneficiary for such accounts, ultimate disbursements from these accounts should constitute support. To me, §529(c)(2) seals the fate. I may have missed it but I don't think I've seen anyone putting forward the technical basis for the alternative position.

---------------------------------------------------------------------------------Still an AllStar

rbynaker

Level 13

I think it's unsettled law, although I'd be curious to know if anyone has a court case on point.

From an old JoA article:

https://www.journalofaccountancy.com/issues/2012/mar/20114558.html

"The IRS has not given guidance on how distributions from Sec. 529 plans affect the support tests. These distributions can be substantial. If the distribution is counted as support provided by the beneficiary (child), it could prevent the child from qualifying as a dependent. Sec. 529 plans allow the owner (usually a parent or grandparent) to change the beneficiary. This provides some support for the argument that Sec. 529 plan distributions should count as support from the account owner and not count as support provided by the child, but tax practitioners are still waiting for a definitive answer from the IRS."

I'd venture a guess to say the answer is muddied in state law (since the majority of 529 plans are state run plans). I'm also thinking the answer may lie in how the money flows. An account owner can take a distribution from the plan, then use those funds to pay the tuition of their child. Or an account owner can direct the plan to pay the school directly. Oddly enough the same end result (school gets paid) results in opposing positions in 1099-Q reporting. For the former, the 1099-Q is issued in the parent's (owner's) name. For the latter, the 1099-Q is issued to the student.

As a thought experiment this may be something of a Schrodinger's Cat problem. The funds are both owner's and beneficiary's until the act of making a distribution determines their fate.

Rick

itonewbie

Level 15

For the sake of discussion though, whether the distribution goes directly from the account to the school or flows through the owner who would then pay for the designated beneficiary's qualified expenses is merely a form factor. The substance remains the same and the latter still operates within the confines of §529(c)(3), which does not provide for a different gift or estate tax treatment.

In fact, when §529 was first enacted as part of Small Business Job Protection Act of 1996, contributions to the program were treated as incomplete gift until distribution. Similarly, such contribution were to be included in the contributor's estate. These were subsequently amended and the current section reflects a completely different view of how the contributions and assets in such account are treated for gift and estate tax purposes.

IMHO, it would be difficult to argue that one can bifurcate on the treatment of these contributions being a complete gift while taking advantage of the tax-free treatment of the plan's earnings and distribution.

Outside the tax realm, for purposes of FAFSA, however, I can see that 529 is treated differently. But given how the tax treatments are codified and in light of the legislative history, I am not so sure that is a tenable position.

---------------------------------------------------------------------------------Still an AllStar

S

szaf12

Level 2

I have a college student who is 18 and received a distribution from a 529 plan with earnings. Subject to the kidde tax?

itonewbie

Level 15

@szaf12 What you have is a different question and this is a very old post. Please create a new post for your question instead.

---------------------------------------------------------------------------------Still an AllStar

S

szaf12

Level 2

I have a college student who is 18 at the end of 2021. She has a distribution from a 529 plan with earnings. She used the total distribution for qualified college expenses. The software indicates that she is subject to kidde tax. Is there an exception somewhere? Or does this situation fall into the blackhole in the legislation?

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