Not everything can be paid for with 529 funds.
Question: Do all expenses listed in a school's Cost of Attendance qualify as Qualified Higher Education Expenses that can be paid out of a 529 account without incurring income tax or a penalty?
Susan: No. Qualified higher education expenses are "(i) tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution; and (ii) expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with such enrollment or attendance." Code § 529(e)(3)(A). Certain room and board expenses also qualify (see question 3 below). For 2010, certain computer and internet expenses also qualify (see question 2 below).
My niece's top college choice right now is Yale, so let's look at Yale's Cost of Attendance for 2009-2010:
Tuition and fees: $36,500
Room and board: $11,000
Books and personal expenses: $3,050
In order to be a qualified higher education expense the expense must be required for enrollment or attendance, and the expense must be for tuition, fees, books, supplies and equipment, or expenses for special needs services. The tuition and fees in the Cost of Attendance are presumably required for attendance and therefore are qualified higher education expenses. Books, supplies and equipment qualify only if they are required for attendance. Thus the actual cost of any books or supplies required for the classes in which the student is enrolled will qualify. Books that are not required, even though they may be highly advisable, such as a good dictionary and thesaurus, do not qualify. (My niece might wonder why anyone would want a paper dictionary instead of using an on-line dictionary.) Supplies not required by the school, for example backpacks, pens, notebooks, and computer paper, do not qualify.
Personal expenses do not qualify, even if included in the Cost of Attendance. Transportation costs also do not qualify, even if included in the Cost of Attendance.
2. Has the special exclusion for computer expenses been extended beyond 2010?
The American Recovery and Reinvestment Act of 2009 temporarily expanded the definition of qualified higher education expenses to include computer technology and equipment, and Internet access and related services, if such technology equipment or services is to be used by the beneficiary and the beneficiary's family during any of the years the beneficiary is enrolled at an eligible educational institution. Explicitly excluded are equipment of a kind used primarily for amusement or entertainment of the user and expenses for computer software designed for sports, games, or hobbies unless the software is predominantly educational in nature. This special rule applies only to expenses paid or incurred during 2009 or 2010.
Thus for 2010 a student's laptop or computer would qualify (assuming it is used primarily for study, not entertainment), even if the school does not require that each student have a computer. This special rule has not yet been extended beyond 2010.
3. What room and board expenses are qualified higher education expenses if the student is living off campus? How should these expenses be documented?
First, room and board expenses are qualified higher education expenses only for certain students. In order to claim room and board expenses, the student must be an eligible student as defined in Code section 25A(b)(3). Code § 529(e)(3)(B). This means that the student must be enrolled in a degree certificate or other program leading to a recognized educational credential and carrying at least half the normal full-time work load for the course of study being pursued. Thus even though I take an evening class at University of Chicago, my room and board expenses are not qualified higher education expenses.
Second, room and board includes "reasonable costs for such period (as determined under the qualified tuition program) incurred by the designated beneficiary for room and board while attending such institution." Code § 529(e)(3)(B)(i). Thus apparently the qualified tuition program could place limits on room and board, or try to define what are reasonable room and board costs.
Third, section 529 limits the amount allowable:
The amount treated as qualified higher education expenses . . . shall not exceed (I) the allowance (applicable to the student) for room and board included in the cost of attendance (as defined in section 472 of the Higher Education Act of 1965 (20 U.S.C. 1087ll), as in effect on the date of the enactment of the Economic Growth and Tax Relief Reconciliation Act of 2001) [June 7, 2001] as determined by the eligible educational institution for such period, or (II) if greater, the actual invoice amount the student residing in housing owned or operated by the eligible educational institution is charged by such institution for room and board costs for such period.
Section 472 of the Higher Education Act of 1965, as in effect on June 7, 2001, defined room and board costs as:
(1) for students living at home with parents, as an amount determined by the institution;
(2) for students residing in housing owned or operated by the school, as a standard allowance based on the amount most of the school's residents are normally charged for room and board; or
(3) for all other students, as the amount of expenses reasonably incurred by the student for room and board.
Code section 529 was amended for years beginning after Dec. 31, 2001 to eliminate the dollar amount limitations on room and board that were contained in the 1996 version of 20 U.S.C. 1087ll and which were reflected in the proposed regulations to Code section 529.
Thus a Yale student living off campus could deduct the actual cost of rent and food to the extent permitted by the qualified tuition program, but not in excess of the room and board charges included in Yale's Cost of Attendance ($11,000 for 2009-2010). Some schools may have different room and board estimates for students living off campus or at home. For example, Illinois State University includes in its 2010-2011 cost of attendance room and board expenses of $8,436 for a student living on campus, $7,479 for a student living off campus and $1,850 for a student living at home.
Are utilities part of room and board? It would seem reasonable that basic utilities such as gas, electricity, water, and sewer if charged to the renter would be part of board, but perhaps not telephone service, cable and internet (although for 2010 internet service may qualify under the special rule discussed in question 2). What about cleaning supplies, personal hygiene items, and other incidental expenses that might be included on a grocery store bill? I would hope that, if off campus room and board is limited to the cost of room and board as shown in the Cost of Attendance, the IRS wouldn't get too picky in reviewing grocery bills, but perhaps it is best to put the beer and personal hygiene items, which would not be included in on campus room and board, on a separate tab. Alternatively, one might document expenses in excess of the amount included in Cost of Attendance, in case the IRS challenges certain items.
Receipts should be retained to document the actual costs. Yes, this includes the grocery bills, receipts for lattes, and fast food receipts. Using a separate credit or debit card solely for room and board expenses may facilitate documentation.
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