How to Avoid Paying Extra Taxes on Your College Refund
529 withdrawal rules may cause you to pay extra if you’re not careful.
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If you haven’t already, you could soon get a refund on certain college expenses as campuses across the country closed and schools shifted to remote learning because of the coronavirus pandemic.
But if you used withdrawals from a 529 college savings account to cover these costs, you should handle these refunds with care to avoid tax penalties.
Here are some things you should know if you’ve opened a 529 plan to help save for education costs, used the funds on tuition or other qualified expenses, and expect to get a refund because of the recent pandemic changes.
How do I avoid tax penalties on my refund?
If you don’t handle your refund correctly, it could be seen as a withdrawal to cover nonqualified expenses, which would be subject to tax penalties.
There are two ways to deal with a refund to avoid paying extra taxes: You can spend the refund on other qualified expenses or put the money back into any 529 account with the same beneficiary. If you choose the latter, the refund must come directly from a college or university, and the timing of when you make the deposit is crucial.
What to keep in mind:
This 60-day rule has shifted slightly in response to the coronavirus pandemic. As stated in IRS Notice 2020-23, 529 account owners who got refunds prior to May 15 now have until July 15 to redeposit the funds into a 529 account. The 60-day window still applies to account owners who receive refunds after May 15.
Could I use my refund to cover next year’s expenses?
While the 60-day period doesn’t apply when you choose to use your refund on other qualified expenses, timing is still important if you want to avoid tax penalties.
What to keep in mind:
What are some expenses that I could use my refund to cover?
You can use tax-free withdrawals from a 529 account to pay for qualified expenses (see Section 8 of this IRS document) that include tuition, mandatory fees, books, computers and software.
Because many colleges and universities have set up online courses, it may make sense to use the money to pay for Internet access or to purchase a computer.
You could also put the refund toward student loans. As part of the Setting Every Community Up for Retirement Enhancement Act, or SECURE Act, up to $10,000 total from a 529 plan can be used to repay the beneficiary’s student loans. This includes federal and most private loans. Further, an additional $10,000 can go toward each of the beneficiary’s siblings’ student loans.
Of course, there's no one-size-fits-all approach to using 529 funds. But it’s important for investors to understand what costs you can cover without any tax penalty.
What are the tax penalties for nonqualified withdrawals?
Transportation, extracurricular activities, health insurance, and other noneducation costs are considered nonqualified expenses.
What to keep in mind:
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