529 Plans & Tax Time

The 2021 tax season is in full swing, and many people are wondering how to handle their 529 accounts during this tax season. As a 529 account owner, do you know what type of IRS reporting needs to be done each year? Some (not all) contributions to your 529 account need to be reported on your tax return, along with some (not all) distributions made from your 529. That's not confusing at all, right? To make it a bit easier to understand, let’s look at some of the most important things you need to know when it comes to 529 contributions and distributions.

Contributions to 529s

If you contribute to a 529 plan, you most likely will not need to report those contributions on your federal tax return. Since contributors do not receive a federal tax benefit for saving to a 529 plan, there is no reason to report contributions to the IRS for federal tax purposes.

However, if you contributed more than $15,000 to a 529 as a single filer or more than $30,000 as a married filing joint filer in tax year 2021, you will need to report your contributions on IRS Form 709 (United States Gift Tax Return). This is because the annual federal gift tax exclusion amounts ($15,000 for single and $30,000 for a couple in 2021) apply to 529 plan contributions. Any contributions over the stated exclusion amounts need to be recorded. So while you will likely not owe taxes on the gifted contributions, you need to keep track of gifts exceeding the annual exclusion amount.

Additionally, if you live in a state that provides a tax credit or deduction for 529 plan contributions, you must report those contributions on your state tax return. For example, Indiana provides a 20% state tax credit up to the first $5,000 of contributions made in a tax year. So, to receive these types of tax credits or deductions, make sure to report your 529 contributions on your state tax return!

Distributions from 529s

If you take withdrawals from a 529 plan, you will receive Form 1099-Q, which reports total withdrawals from 529 plans. Withdrawals from 529 plans made for qualified education expenses do not need to be recorded on your federal or state tax return. Qualified education expenses can include tuition, books, technology, fees, and room and board costs. Plan owners can also distribute up to $10,000 tax-free per year for private elementary through high school tuition. Additionally, a one-time distribution up to $10,000 can be withdrawn to repay a designated beneficiary's (or a designated beneficiary's sibling's) student loans with no tax consequences.

However, withdrawals made from 529s for non-qualified purposes must be reported on your tax return. If your withdrawal includes investment earnings, the earnings portion of the withdrawal will be taxable and a 10% penalty will be assessed. To determine the taxable amount of the withdrawal, use form 1099-Q to break out the investment earnings portion of the withdrawal. The amount originally contributed, or "the basis", will never be taxed. In addition, your state of residence may recapture a portion of any state tax credit or deduction received when a non-qualified withdrawal is made.

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