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Matching 529 Distributions with Expenses

Plus, a case study on the key considerations when using 529 accounts in an irrevocable trust.

Susan T. Bart, 07/26/2012

1. I paid my son's spring tuition for 2012 with a check dated 12/23/11. I don't remember when I mailed the check, but it did not clear until 1/9/12. I am just now getting around in May to doing the 529 distribution for reimbursement. It seems that if this counts as a 2011 expense, I am outside the supposed grace period until March 2012 to do the distribution. If it counts as a 2012 expense, I'm obviously fine. Any thoughts as to whether it counts as a 2012 expense since the check only cleared in 2012?

There's very little guidance on when qualified expenses must be paid in order to make a 529 distribution a qualified distribution. Clearly if the distribution and the payment are in the same year, there shouldn't be problem. The Advance Notice of Proposed Rulemaking on Section 529 (published in the Federal Register, Jan. 18, 2008) proposes a rule that, in order for earnings to be excluded from income, any distribution from a section 529 account during a calendar year must be used to pay qualified higher education expenses in the same calendar year or by March 31 of the following year. The rule proposed in the Advance Notice, however, does not apply in your case if the expense was paid in 2011 because you would be applying a distribution to an expense paid in a prior year.

It would be helpful if the proposed regulations would also exclude from income any distribution from a section 529 account during a calendar year that is used in reimbursement of qualified higher education expenses paid during the last three months of the prior year. While we are waiting for further guidance, this may be a reasonable position that the IRS would accept.

If in your case the educational expense was actually paid in 2012, then you do not have an issue as the distribution and the expense would be in the same year. When an expense is paid by check, for tax purposes the payment generally is considered as having been made when the check is delivered or mailed (unless the check is postdated or remains under the control of the taxpayer). Thus if you mailed the check in 2012, you should have no issue.

2. We have an irrevocable trust that was established by Husband and Wife for the child of the Wife by her first marriage (Wife's Child), the children of Husband and Wife (Joint Child 1 and Joint Child 2), and their respective descendants. Husband and Wife subsequently divorced and Husband remarried and had an additional child (Husband's Child). By court order the trust was modified to include Husband's Child and such Child's future descendants. The trust is primarily for the college education of all of the descendants.

Wife's Child has completed her education and has two minor children (Wife's Grandchild 1 and Wife's Grandchild 2). Joint Child 1 has completed his education and has one minor child (Joint Grandchild). Joint Child 2 has completed her education and currently has no children. Husband's Child is a minor and has no children.

The Trustee would like to use the trust assets to establish six equal shares, one for each of the three living grandchildren, one for Husband's Child, who has not completed her education, one for the future children of Joint Child 2, and one for the future children of Husband's Child. Can 529 accounts be used for all six shares?

Here's a family tree to help us keep things straight:

Susan T. Bart is a partner in the Private Clients, Trusts & Estates Group at Sidley Austin LLP in its Chicago office, where her practice includes estate planning, estate and trust administration, and fiduciary counsel. She has written two books, including Education Planning and Gifts to Minors published by Illinois Institute for Continuing Legal Education (iicle.com), which extensively discusses 529 plans.

She is the author of Education Planning and Gifts to Minors 2004 Edition. She is a frequent speaker on trust and estate topics in general and Section 529 college savings plans in particular.

The author is not an employee of Morningstar, Inc. The views expressed in this article are the author's. They do not necessarily reflect the views of Morningstar. The author is a freelance contributor to MorningstarAdvisor.com. The views expressed in this article may or may not reflect the views of Morningstar.

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