Even Saving for College Has a Potential to Lead to Tax Issues

When it comes to IRS tax problems, many taxpayers think it could never happen to them. Unfortunately, there are seemingly endless ways in which a person could find themselves having to sort out a tax mess. One such example involves the popular college savings vehicle known as a 529 plan.

What Is a 529 Plan?

With the cost of a college education on the rise, many taxpayers are taking advantage of tax savings vehicles to help save for tuition for their children and grandchildren. One popular option used by many families is a 529 plan. These plans offer various tax benefits to taxpayers as long as the money being saved is used for qualified educational purposes. Unfortunately, there are potential pitfalls that all taxpayers should be aware of.

For many taxpayers, the ability to save money that can grow without incurring tax is a major appeal when trying to save for future college expenses. In that way, a 529 plan is similar to an IRA and a 401(k). State 529 plans allow you to invest in the market and let your earnings grow tax free. As long as the money is later used to pay for educational expenses, the earnings from the account are not taxed when they are withdrawn. This is where some people get themselves into trouble.

How a 529 Plan Can Lead to Tax Problems

One aspect of a 529 Plan than can be tricky is the timing of the withdrawals. The following is an overview as to why:

  • Taxpayers must initiate the withdrawals from the plan because colleges and universities do not have direct access to the account.
  • Semesters and quarters typically end in December and begin in January.
  • Funds must be withdrawn from the 529 account in the calendar year in which the bill is actually paid.
  • If you withdraw the funds in one calendar year and pay the bill in another, negative tax consequences may result.
  • Further, taxpayers can run into trouble because withdrawals from 529 plans are not instantaneously available. It can take up to two weeks for the funds to be processed. This can result in the year-end mismatch issue note above.

In order to avoid this issue, it is important to leave ample time for processing and to plan ahead with regard to when to schedule your distributions and payments.  If you are caught at the end of the year facing a problem, you can pay the tuition yourself and request a reimbursement from the 529 plan. It is important to keep documentation that shows the expenses at least match the withdrawal amount. Another option is to have the withdrawal paid directly to the school rather than being paid into your account.

If you made a mistake with regard to a 529 Plan withdrawal or are facing another type of tax problem, rest assured that you do not have to deal with it alone. We are here to help. Learn more about the experiences of our previous clients by checking out our client testimonials today.

 

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