Tax questions regarding nonqualified distributions from 529

[SecondCor521]

Hi all,

My oldest son will be my tax dependent this year. He is single, 24, and not blind.

I am considering taking a non-qualified withdrawal from his 529 this year.

According to Pub 970 Chapter 8, this withdrawal would result in taxable income to him which would be reported on Schedule 1 line 21 (using 2018 tax form line numbers).

Question 1: Would this income be considered earned income or unearned income (or neither?) for the purposes of looking at Chart B for Dependents in the Form 1040 instructions when deciding whether or not he needs to file?

I'd like to take the position that it is earned income, because it would be similar to "taxable scholarships and grants" listed at the top of Chart B.

Also according to Pub 970 Chapter 8, there is "generally" an additional 10% tax on withdrawals with a list of five exceptions, with tax free scholarships being exception 3a. My son has received scholarships that would qualify him for exception 3a.

If we treat this withdrawal as earned income, then according to Chart B my son would not be required to file an income tax return because his earned income would be below the ~$12K limit.

Question 2: If my son is not required to file an income tax return, then does it follow that he would not have to pay the additional 10% tax on withdrawals?

My son plans to attend college full time next year and will probably have close to zero earned income. (He may earn a few thousand in an internship.)

I plan to give my son the left over balance of his 529 next year when he graduates. He plans to liquidate the 529 and put it into his house down payment funds (he has no plans for children and no plans for graduate school). That liquidation event will be a non-qualifying distribution as well.

Question 3: If he doesn't have to pay the additional 10% tax on withdrawals, does that mean that he can fully preserve his "exception 3a" qualifying scholarships for next year's liquidation event so he doesn't pay the 10% penalty next year?

[njhowie]

Be aware, that only the earnings portion of your non-qualified withdrawal would be taxable and subject to any penalty. 970 explains how distribution of the contribution portion is considered a return of capital and never taxable.

When you receive the 1099 at tax time, it will indicate how much was earnings. In the mean time, you should be able to get a rough idea by reviewing your account online or recent account statements.

Unless the value of the 529 has skyrocketed due to earnings (above contributions), the amount of tax due is likely less than you are figuring.

[SecondCor521]

Quote:

Originally Posted by njhowie Be aware, that only the earnings portion of your non-qualified withdrawal would be taxable and subject to any penalty. 970 explains how distribution of the contribution portion is considered a return of capital and never taxable. When you receive the 1099 at tax time, it will indicate how much was earnings. In the mean time, you should be able to get a rough idea by reviewing your account online or recent account statements. Unless the value of the 529 has skyrocketed due to earnings (above contributions), the amount of tax due is likely less than you are figuring.

Thanks for the reply.

Yes, I'm aware of that.

Unfortunately, I can't rely on the 1099, because I have also made qualified withdrawals from his 529 this year as well. I'm also using the AOTC for him this year, and have made ESA withdrawals for him as well. So I have to go through the examples in Pub 970 and do those sorts of allocation calculations.

My questions in the original post remain.

Since I know Other Income on Schedule 1 line 21 does not qualify one for a Roth contribution, I'm now thinking the answer to my first question is that it only counts as unearned income.