529 room and board

[camfused]

Hey. I Googled for this, but was not able to find a clear answer...

Daughter has a 529 plan, and will be a full-time (9 hours) grad school student, for an online degree (campus is in another state somewhere). Can she use 529 funds to pay for room and board (equivalence amounts set by the school, I imagine) if
a) she lives at home while taking the online classes and pays me room and board, or
b) she lives in a local apartment (not near the campus) while taking the online classes

Thanks!

 

[njhowie]

a) If she pays you room and board, then you will need to declare it as income.

b) I do not see anything which differentiates online vs. in-person, or that room and board can be paid with 529 funds if "close" to campus. The only requirement is that she be at least a half-time student.

...(equivalence amounts set by the school, I imagine)

That is correct.

 

[camfused]

^^^^ Thanks. For a), I have read that *maybe* that is not income, but either 1) can be a "gift" (which is ok for up to $14K/year, or whatever the gift limit is this year), or 2) if I charge her the cost of actually housing and feeding her, my net is 0, and therefore no income. What do we think?

 

[njhowie]

^^^^ Thanks. For a), I have read that *maybe* that is not income, but either 1) can be a "gift" (which is ok for up to $14K/year, or whatever the gift limit is this year), or 2) if I charge her the cost of actually housing and feeding her, my net is 0, and therefore no income. What do we think?

1) Meaning she gifts you the room and board money? From the 529 funds? Not going to fly.

2) This is possible, but will get tricky, as it is similar to the home office expense/deduction. I would read up on how folks go about doing that as I believe the calculations would be similar. You'll be taking a pro-rated amount of the monthly housing expenses and allocating to her. If you go this route, be sure to keep good documentation in the event you have to show what you've done if the IRS questions it.

 

[SecondCor521]

The authoritative answer is in Pub 970 at the IRS website. In their parlance, a 529 is a Qualified Tuition Plan (QTP) which is discussed in Chapter 8. To determine whether a withdrawal is taxable, look on page 58, left column. Room and board while not living on campus is item 3a in that list. As njhowie notes and Pub 970 confirms, your daughter would need to be at least half-time as determined by her school.

What I do is call or visit the school and ask them for the cost-of-attendance (COA) for that semester for room and board. Note that the COA number the university provides may depend on what they have listed as the living arrangement of the student - my son's university has "living off campus in an apartment" COA, and "living at home with parents" COA. Since my son lives with me, I use the latter number.

Currently my son doesn't pay me anything for the food/shelter/utilities/etc because he's in school full-time and that's our agreement. But at times in the past when he has paid me for that, I do not include it as income because I don't consider it rent. It is not rent because (a) we have no rental agreement, (b) I don't charge late fees, and (c) if he didn't pay it I would not kick him out or stop feeding him. So I disagree with njhowie's opinion on this one.

https://www.irs.gov/pub/irs-pdf/p970.pdf

 

[njhowie]

Currently my son doesn't pay me anything for the food/shelter/utilities/etc because he's in school full-time and that's our agreement. But at times in the past when he has paid me for that, I do not include it as income because I don't consider it rent. It is not rent because (a) we have no rental agreement, (b) I don't charge late fees, and (c) if he didn't pay it I would not kick him out or stop feeding him. So I disagree with njhowie's opinion on this one.

https://www.irs.gov/pub/irs-pdf/p970.pdf

If he's not paying you anything, then there are no room and board expenses and so you are not making a qualified withdrawal from the 529.

Is this where the gifting camfused brings up comes into play? In the other direction?

I think this line of reasoning is weak. However, as I mentioned elsewhere on a 529 thread, as long as you're not doing something incredibly wrong/bad, it's extremely unlikely that anything would ever come of it. The IRS simply does not have the resources to verify every 529 withdrawal and confirm where the funds actually went. So, at the end of the day, if you are comfortable with what you are doing, keep good documentation, and can justify what you've done in the unlikely event you are audited, then that's all that matters.

 

[OldShooter]

My attitude on most questions like this is to remember what my tax CPA once told me: "If you never get audited, you're not trying hard enough." Actually, I have never been audited even when he was helping me try.

So I say just stretch the rules any way that you can reasonably interpret them, then wait to see if you get audited. And wait. And wait. The audit rate for individual taxpayers is something like 0.5%, so one chance in 200. If you are reporting exotic stuff, maybe it's higher. But a 529 is hardly exotic.

 

[EastWest Gal]

Publication 970 refers to qualified educational expenses for a tax deduction and does not apply here. Educational expenses deduction applies only to the first four years of higher education, and only applies to tuition and fees.

Grad school is full time with 8 semester units or more, so you're fine. I initially thought your idea couldn't work, but apparently, it does. The second paragraph if the previous post by SecondCor521 is accurate, IMO.

According to the website, Saving For College, "Colleges typically have a room and board budgets for students who live on campus in college owned or operated housing, for students who live off-campus in an apartment and for students who live off campus with their parents or other relatives."

https://www.savingforcollege.com/article/using-your-529-plan-to-pay-for-room-and-board

Then if she gave you the COA amount as a gift, there should be no tax consequence. Agree with checking with the school regarding the "living with relative" allowable amount. Since this is a gift, you do not need to report income. You may want to have her write a letter stating she is giving you the gift, and keep it, along with the COA amount by the school together in your files in case the IRS comes knocking.

 

[SecondCor521]

If he's not paying you anything, then there are no room and board expenses and so you are not making a qualified withdrawal from the 529.

Is this where the gifting camfused brings up comes into play? In the other direction?

I think this line of reasoning is weak. However, as I mentioned elsewhere on a 529 thread, as long as you're not doing something incredibly wrong/bad, it's extremely unlikely that anything would ever come of it. The IRS simply does not have the resources to verify every 529 withdrawal and confirm where the funds actually went. So, at the end of the day, if you are comfortable with what you are doing, keep good documentation, and can justify what you've done in the unlikely event you are audited, then that's all that matters.

I had read pub 970 quite a lot, and was going to write a spirited defense of my position, but in reviewing the relevant section I had missed the phrasing at the beginning of the paragraph in 3a where it says "Expenses for room and board must be incurred by students..."

Certainly one could argue that he has "incurred" expenses because he's eating food, which costs money. The board question is a little more ambiguous, as he's living in my house, which I owe outright. But I do pay electricity/water/gas/sewer/trash, which are actual expenses and things he uses. And as mentioned above, in neither case do I charge him for any of these things. What I don't know is whether the portion of those costs which I could reasonably allocate to him - which would be an accounting hassle - are equal to, less than, or greater than the COA.

I'm not sure I understand your comment about camfused and gifting. I do think a lot of gifting goes on within families in all directions.

I agree with your last paragraph, and I have always said in addition to what you wrote, that I am willing to go into an audit, explain my position, have them tell me I'm wrong, learn from my mistake, and pay whatever penalties and interest they say to pay. I generally hope that if I have read the rules carefully, made an honest effort to apply them to my situation, and keep good records, I at least will not get thrown into prison.

I'll have to revisit my practices. Thanks for the response.

 

[cathy63]

My attitude on most questions like this is to remember what my tax CPA once told me: "If you never get audited, you're not trying hard enough." Actually, I have never been audited even when he was helping me try.

So I say just stretch the rules any way that you can reasonably interpret them, then wait to see if you get audited. And wait. And wait. The audit rate for individual taxpayers is something like 0.5%, so one chance in 200. If you are reporting exotic stuff, maybe it's higher. But a 529 is hardly exotic.

I would just like to point out that there are other ways for the IRS to question your tax return than by auditing you. We did get questioned on a 529 withdrawal one year because I made a completely unrelated error entering a corrected W-2.

It turns out that if the IRS computer spits out your return because of a mismatch on one document, then they look at the entire thing and send you a letter telling you what they have "corrected". So we got: "We owe you $x for this W-2 you entered incorrectly, and you owe us $y for not reporting this taxable 529 withdrawal, plus $z penalties. Please sign here and send a check for $y-$x+$z." We had a 1098-T for more than the 529 withdrawal, so not a big deal to write a letter explaining they were wrong on the 529 and still get the refund on the W-2.

But I'd say if you're going to stretch the rules in one way, do try extra hard to avoid drawing attention to your return for some other reason!

 

[skibum]

For UC Berkeley, qualified 529 housing expenses when living with relative is $2704 "housing and utilities" ($10,868 in off campus apt), and $3808 food. It seems reasonable to me that qualified 529 withdrawals in these amounts can be claimed to IRS, with no tax liability to the host relative, as these would be actual expenses paid to the utility company or grocery stores. This is an interpretation suitable for me, others may have different or more knowledgeable interpretations. Perhaps scale it down by 20% for food and utilities only.

For us the actual tax implications are rather minor though. For $6k of non-qualified withdrawal, approx $2k of this are gains that would be taxable, and at 10-12% tax rate for the student, the actual tax is $220. Of course the gains and tax rates are unique to each case, but the actual tax may not be especially significant.

 

[SecondCor521]

For us the actual tax implications are rather minor though. For $6k of non-qualified withdrawal, approx $2k of this are gains that would be taxable, and at 10-12% tax rate for the student, the actual tax is $220. Of course the gains and tax rates are unique to each case, but the actual tax may not be especially significant.

I thought non-qualified withdrawals were subject to income tax and a 10% penalty (unless the withdrawal qualified for an exemption to the 10% penalty), so in the case you describe, it would be the $220 in tax plus $200 in penalty. Too lazy to look it up now, and my kids have plenty of scholarships to qualify for an exemption to the 10%. Just have to keep track.

 

[skibum]

My mistake, plus 10% penalty on earnings. We've exceeded the allowed costs by a few grand for most years, Turbotax calculated the taxes, it did not seem to amount to much, I must have overlooked the penalty calcs. I'll have to look back at the returns, and take a closer look at the exemptions to manage the residual 529 balances.

 

[SecondCor521]

My mistake, plus 10% penalty on earnings. We've exceeded the allowed costs by a few grand for most years, Turbotax calculated the taxes, it did not seem to amount to much, I must have overlooked the penalty calcs. I'll have to look back at the returns, and take a closer look at the exemptions to manage the residual 529 balances.

The penalty would show up on Form 5329.

There are a number of exceptions to the 10% penalty, but the most commonly used one is if the student received scholarships. I think the exceptions are listed in Pub 970 as well (yup, just checked, they're on page 60).

 

[sengsational]

I'd get the budget from the school for the type of student in question, withdraw the entire amount in one transaction (for the entire academic year, including spring semester) and move on with my life. You are not trying to "get away with anything". If the IRS asks, it will probably be a form letter. You'd send them whatever paperwork you have. And say you came up short of the total. So what. You refigure the tax. It's peanuts. The IRS isn't going to be interested in peanuts on a guy who's basically doing exactly what the law makers intended.

 

[OldShooter]

I would just like to point out that there are other ways for the IRS to question your tax return than by auditing you. We did get questioned on a 529 withdrawal one year because I made a completely unrelated error entering a corrected W-2.

It turns out that if the IRS computer spits out your return because of a mismatch on one document, then they look at the entire thing and send you a letter telling you what they have "corrected". So we got: "We owe you $x for this W-2 you entered incorrectly, and you owe us $y for not reporting this taxable 529 withdrawal, plus $z penalties. Please sign here and send a check for $y-$x+$z." We had a 1098-T for more than the 529 withdrawal, so not a big deal to write a letter explaining they were wrong on the 529 and still get the refund on the W-2.

But I'd say if you're going to stretch the rules in one way, do try extra hard to avoid drawing attention to your return for some other reason!

Sure, we've gotten those. IIRC was one for a missed 1099, so we paid up. Another was for a W-2 DW received due to her cashing some stock options --- not employment income. Making that one go away took quite a while and a couple of meetings at the local IRS office. A third one ended up with my paying my CPA to write a letter to the IRS explaining their own regulations to them.

But your experience really supports my point, that real audits are vanishingly rare and the type of 529 interpretations we are talking about here probably will not show up in the automated paperwork reviews that the IRS does. The paperwork reviews are very cost-effective; actual audits of ordinary taxpayers almost certainly are not. But you are certainly right that trying extra hard to not get zapped via a paperwork review is a good idea. Probably it's a good idea any time under the universal never-wake-a-sleeping-bear policy.

 

[skibum]

SecondCor521. Thanks for the correction and insights.

My eldest graduated college this year and I distributed the residual 529 funds as planned. I used turbotax to calculate a provisional return to estimate withholding as he entered the work force. I actually highlighted the 10% penalty on form 5329T line 8, approx $500 on $5k earnings from $15k non-qualified distribution. I must have blocked out the penalty in writing the initial post, glad my projection was correct. It pains me to eat the penalty on excess 529 funds, though it is a small fraction of the 529 tax free earnings.

 

[SecondCor521]

SecondCor521. Thanks for the correction and insights.

My eldest graduated college this year and I distributed the residual 529 funds as planned. I used turbotax to calculate a provisional return to estimate withholding as he entered the work force. I actually highlighted the 10% penalty on form 5329T line 8, approx $500 on $5k earnings from $15k non-qualified distribution. I must have blocked out the penalty in writing the initial post, glad my projection was correct. It pains me to eat the penalty on excess 529 funds, though it is a small fraction of the 529 tax free earnings.

If your eldest had any scholarships, you can avoid paying that $500. It is my interpretation of the rules that the IRS does *not* require that those scholarships were received this year; they could have been from your child's freshman year (when scholarships are more common). Again, see Pub 970 page 60 right hand column item 3a.

You'll still owe the income tax on the earnings portion.

 

[Koolau]

My attitude on most questions like this is to remember what my tax CPA once told me: "If you never get audited, you're not trying hard enough." Actually, I have never been audited even when he was helping me try.

So I say just stretch the rules any way that you can reasonably interpret them, then wait to see if you get audited. And wait. And wait. The audit rate for individual taxpayers is something like 0.5%, so one chance in 200. If you are reporting exotic stuff, maybe it's higher. But a 529 is hardly exotic.

I supervised a guy who took this attitude. Unfortunately, he didn't have a "plan" in case the IRS came calling - which they did. He had been operating a small business (resale of some kind IIRC). So, since he (apparently - this is 2nd hand) had not kept business records very carefully, he had to "create" some, and had to purchase (at $2.50 each) copies of all of the checks he ran through his CU. Cost a small fortune. Long and short of it: He did stay out of jail, he did have to pay significant penalties, he did have to pay his back taxes. I'd say he got lucky (other than being audited, that is.) He wasn't worth a flip at w*rk for 6 months. It aged him (now, long since deceased, RIP).

My point, if there is one: If you're going to tempt the IRS to audit you, be sure you have a very good back up plan AND be ready, willing(?) and able to pay the piper. Just my 2 cents worth, so YMMV.

 

[OldShooter]

... My point, if there is one: If you're going to tempt the IRS to audit you, be sure you have a very good back up plan AND be ready, willing(?) and able to pay the piper. Just my 2 cents worth, so YMMV.

Which is exactly why I said "stretch the rules any way that you can reasonably interpret them." Then, if the IRS comes calling you have a credible opening position in negotiations. They can argue about your interpretation but cannot call you a criminal. Outright fraud, which is what you are talking about, is an entirely different matter.

 

[The Cosmic Avenger]

I'd get the budget from the school for the type of student in question, withdraw the entire amount in one transaction (for the entire academic year, including spring semester) and move on with my life. You are not trying to "get away with anything". If the IRS asks, it will probably be a form letter. You'd send them whatever paperwork you have. And say you came up short of the total. So what. You refigure the tax. It's peanuts. The IRS isn't going to be interested in peanuts on a guy who's basically doing exactly what the law makers intended.

Actually, I think the lawmakers intended for people to basically reimburse themselves for money already spent. From what I understand you are only supposed to withdraw money for expenses already incurred in that calendar year. So for next spring 2021, I'd wait until at least January 2021, unless you can somehow pay the bill by the end of December. No point in doing something that you know won't hold up in an audit. I've been totaling up the money spent, including on a laptop and books, and making transfers from the 529 for the actual amounts spent, because what if the expected outlay changes? This way is a lot simpler.

And it's not just the tax, there's a 10% penalty, too.

 

[SevenUp]

Actually, I think the lawmakers intended for people to basically reimburse themselves for money already spent. From what I understand you are only supposed to withdraw money for expenses already incurred in that calendar year.

There is nothing in 26 U.S. Code § 529 - Qualified tuition programs that says a 529 distribution must be preceded by the expense justifying the distribution. Even the linked Kiplinger article says only “The expense and the distribution must be in the same year.”

 

[SevenUp]

I had read pub 970 quite a lot, and was going to write a spirited defense of my position, but in reviewing the relevant section I had missed the phrasing at the beginning of the paragraph in 3a where it says "Expenses for room and board must be incurred by students..."

Perhaps the important words in that sentence are "Expenses for room and board must be incurred by students who are enrolled at least half-time...."

It's not that the student has to pay. It also doesn't matter whether a parent writes a check to the school dormitory and dining halls for a campus-resident student, or pays the local grocery stores, utility companies, etc., for a live-at-home student.

Both situations provide legitimate room and board expenses.

 

[The Cosmic Avenger]

There is nothing in 26 U.S. Code § 529 - Qualified tuition programs that says a 529 distribution must be preceded by the expense justifying the distribution. Even the linked Kiplinger article says only “The expense and the distribution must be in the same year.”

Right, that's why I didn't say that you needed to do it that way, just that that's the easiest way to make sure that you don't overwithdraw, since there's a 10% penalty on top of taxes. I mostly meant to address the suggestion that someone withdraw funds now to be spent next year, which is definitely not allowed.

 

[sengsational]

The tuition for spring is typically paid before the end of the year, and is part of the preceding academic year. That aside, you will get different opinions on whether the timing must match. I've seen statements like the Kiplinger one and I've also seen other expert opinions that disagree with that statement. Last I looked, the IRS hasn't made definitive guidance.