529 education Plan fund withdrawal 3 month after opening the account

[khorshed]

Client opened a 529 education plan for his grandchild. deposited $80K to the account in Sep 2024.

then someone told him bcs it's more then $16K he needs to file 709 for for the next 5 years. So he went ahead and took out $64K out in Dec 2024. I am 100% sure the brokerage firm will report it to the IRS.

my question is, how to handle it when we file 2024 taxes.

[Terry53029 · Accepted solution]

The basis will not be taxable, but earnings will be taxed, and a 10% penalty if not used for education. From pub 570: 

Earnings and return of investment. You will receive a Form 1099-Q from each of the programs from which you received a QTP distribution in. The amount of your gross distribution (box 1) shown on each form will be divided between your earnings (box 2) and your basis, or return of investment (box 3). Form 1099-Q should be sent to you by January 31, 2024.

[IRonMaN]

Sounds like some really good planning was done on funding that 529 plan 😬

[Taxes-by-Rocky]

I'm going to go with....."not a client you want?"

[TaxHero]

Thank you 

[TaxHero]

just for clarification the 10% penalty it would be on the earnings not the basis. correct? 

[Jim-from-Ohio]

correct, on gains only

[sjrcpa]

And what's wrong with filing a gift tax return?

You can elect to treat the gift as made ratably over 5 years. 1/5 of $80 is less than the annual exclusion so he's not even eating into his lifetime $13 million exemption.

If no other gifts made in Years 2-5 no filing required.

[james2526]

How should the $64K withdrawal from the 529 plan and the initial $80K contribution be reported on the 2024 tax return, and what steps should be taken to properly address the potential IRS reporting and Form 709 requirements?

[Taxes-by-Rocky]

How was the account set up?  Who is the donor, who controls the account, and who is the beneficiary?  Could be three separate individuals.  IRC 529 has certain rules (proposed regs) that are contrary to what you'd expect for gift and estate tax purposes. 

Who was the owner of the funds when they were in the account?  Were they distributed to the beneficiary of the account, or back to the donor?  Would there be a completed gift from the beneficiary back to the donor?

Whose Form 1040 has to pick up the income and penalties, if any?  Who will the sponsor/custodian issue the Form 1099-Q to?

Just some observations.