Education Savings Accounts and Qualified Tuition Programs Offer Tax Benefits to Pay for Higher Education

Federal benefits and tax expert, Ed Zurndorfer, discusses ESAs and QTPs including who is eligible to participate, what type of higher education expenses they will pay for, and the tax benefits associated.

Education Savings Accounts (ESAs) and Qualified Tuition Programs (QTPs) offer tax benefits for paying the costs of higher education. This column discusses ESAs and QTPs including who is eligible to participate, what type of higher education expenses they will pay for, and the tax benefits associated with ESAs and QTPs.

Education Savings Account (ESA)

The ESA is a trust established to pay qualified education expenses of a designated beneficiary. Contributions to ESAs are always nondeductible and therefore no tax savings. But earnings in the ESA grow tax-free if when withdrawn are used to pa for qualified educational expenses.

ESA Contributions

· Total contributions limit to all ESAs set up for any one beneficiary from contribution is $2,000 per year.

‣ Contributions are made with after-taxed dollars and not deductible for federal income tax purposes.

· Any individual (including the beneficiary) may contribute to an ESA.

· There is a modified adjusted gross income (MAGI) phase-out for ESA contributors, namely: For married filing joint tax filers: $190,000 to $220,000 and for all other tax filers: $95,000 to $110,000. MAGI is adjusted gross income plus any exclusion for foreign earned income or housing, any foreign housing deduction, and for income from certain U.S. possessions and Puerto Rico.

· Contributions are not allowed for a beneficiary over age 17, unless the beneficiary has special needs.

· Contributions for the year must be made by the return due date (not including extensions). This means 2020 ESA contributions must be made by April 15, 2021.

ESA Withdrawals

· ESA withdrawals are tax-free up to the amount of the beneficiary’s qualified education expenses for the year.

· If the withdrawals are more than the beneficiary’s qualified education expenses for the year, a portion of a withdrawal is taxable to the beneficiary. This excess withdrawal is allocated to accumulated earnings (taxable) and return of basis or ESA contributions (nontaxable). The taxable portion is reported as other income on Form 1040, Schedule 1 (Part I – Additional Income, line 8). Taxable withdrawals are also subject to a 10 percent penalty, unless an exception applies.

· In general, any ESA balance that is not used for education balances must be distributed within 30 days after a beneficiary reaches age 30. The beneficiary is then taxed on the earnings portion of the distribution and a 10 percent penalty applies. This rule does not apply to a special needs beneficiary.

Qualified Education Expenses (QEE)

· Qualified post-secondary expenses include:

(1) tuition, fees, books, supplies and equipment required for attending an eligible school;

(2) expenses for special needs services to attend an eligible school;

(3) contributions to a qualified tuition program (see below);

(4) room and board if student attending at least half-time;

(5) the cost of computer or peripheral equipment computer software, internet service and related services.

· Qualified elementary and secondary school expenses (kindergarten through 12th grade) include:

(1) tuition, fees, academic tutoring, books, supplies, and other equipment needed for enrollment at a public, private or religious school;

(2) special-needs services for a special-needs beneficiary;

(3) room and board, uniforms, transportation and supplementary services (including extended day programs) that are required or provided by the school ; and

(4) cost of computer technology or equipment including internet and related services.

Rollover Rules

Tax-free rollovers are allowed into another ESA for the same beneficiary or for certain family members. In general, family members must be under age 30 at the time of the rollover. But a special-needs beneficiary is not required to be under age 30. Only one rollover is allowed per 12-month period and it must be completed within 60 days after the date of withdrawal.

Qualified Tuition Program (QTP)

Qualified Tuition Programs (QTPs) are authorized in Internal Revenue Code (IRC) Section 529. A QTP allows an individual to make contributions to an account or program in order to pay qualified education costs. Note that QTPs are sometimes called 529 plans.

There are two types of 529 plans namely:

(1) prepaid programs in which contributions are used to purchase tuition credits for a designated beneficiary (student); and

(2) savings account plans in which contributions made to an account established to pay for the qualified education expenses of a beneficiary (student).

QTP Contributions

· The QTP contributor is not subject to any income limitation.

· The amount that can be contributed to a QTP is limited to the amount necessary to provide for qualified expenses of the beneficiary (as determined by the plan).

· The contribution is considered a completed gift, excluded from the contributor’s estate.

· Contributions to a QTP are not deductible for federal income tax purposes.

QTP Distributions

· Distributions of earnings from QTPs are excluded from income of the QTP owner if used for qualified education expenses (QEE of a beneficiary. There are no income tax return reporting requirements in that case. If distributions are more than the beneficiary’s qualified expenses, the earnings portion of the excess is included in the beneficiary’s income.

· The earnings portion of distributions not used for QEE are also subject to a 10 percent penalty.

· Individual should receive Form 1099-Q (Payments from Qualified Education Programs) from the QTP custodian showing earnings and basis related to a QTP distribution.

Qualified Education Expenses (QEE)

QEE include:

(1) tuition, fees, books, supplies, and equipment required for enrollment or attending an eligible school;

(2) tuition required for enrollment or attendance at an elementary or secondary public, private or religious school. These costs are limited to $10,000 per tax year on a per-student basis;

(3) reasonable costs of room and board for those who are at last half-time students in a higher-education degree program;

(4) expenses for special needs services incurred in connection with enrollment or attendance at an eligible school; and

(5) expenditures for computer or peripheral equipment, computer software or intent access.