Distributions from 529 college savings plans, tax-advantaged accounts for secondary education, can be used to pay for school—but not all expenses can be paid for via 529s. Expenses deemed required by the Internal Revenue Service for attendance at a given school are known as Qualified Higher Education Expenses. If an expense is allowed, according to the IRS, parents can distribute funds to cover it without potentially incurring a tax penalty and paying income tax on earnings.
Tuition and fees are allowed, but other expenses require more research, says Gregg Wind, Partner at Los Angeles-based public accounting firm Wind & Stern. For instance, room and board is considered a required expense but there are restrictions, such as cost limits for off-campus housing and enrollment requirements (half time or greater) for students, he says.
To avoid tax penalties, two CPAs offer this advice:
1. Confirm room and board costs with university financial aid offices: If students live off campus in housing not owned or operated by the university, Washo Financial CPA and Personal Financial Specialist Jason Washo advises paying attention to the IRS standard for room and board, which is "the larger of the cost of attendance (for financial aid purposes) or the amount charged by the university for housing that is owned or operated by them."
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For instance, if university-owned housing is $600 per month, you can't take more than this amount as a 529 distribution to pay for rent. This doesn't mean that your student can't rent a higher-priced apartment, Washo says. However, the remaining portion of rent after the allowed amount should come from other accounts—otherwise you should expect to pay the tax penalty, he says.
Never go by national housing averages; cost of attendance estimates are based on individual school expenses, Wind says. Why is it important? The cost of living varies drastically from city to city. Wind notes that you wouldn't expect the same housing expenses in New York and Des Moines, Iowa, so he advises consulting the student's college for qualified room and board costs.
2. Don't utilize 529 distributions for lifestyle expenses: Furnishing an apartment is not part of room and board, Washo says. A student could buy a big screen TV, couch, sofa, kitchen table, but none of this is deemed necessary to attend college, he notes.
These would be considered lifestyle expenses, Washo says. "A very social butterfly may decide to throw a party every Friday or Saturday night, spending $400 on appetizers and drinks; this is not a qualified education expense, even if deemed a study party," he says. Sports or club activity fees also do not qualify, Wind says.
3. Confirm which books and supplies are required: Textbooks are qualified education expenses, but a study guide not included on the required course list may not be, Wind says. Computers are not allowed to be purchased using a 529 distribution, unless it's required by the university for attendance, he says.
A paper trail is important, Washo notes. If a computer is bought with a 529 plan distribution, print any supporting material from the university website showing that students are required to own one.
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4. Keep separate receipts for any money spent or reimbursed with a 529 distribution: Be careful about spending purchasing other items in the same transactions as qualified expenses, Washo says. For instance, you don't want to provide a grocery store receipt to prove you were spending money for groceries within the allowed education expenses amounts if that receipt also includes things like hair products, alcohol, or a blender, he says.
You would also want to be careful buying school t-shirts, hats, and other school team gear from the school bookstore on the same receipt as textbooks. Keeping receipts separate and organized will make it easier to prove which expenses were paid for with 529 distributions, Washo says, in case of a tax audit.
Reyna Gobel, frequently quoted as an expert on student loans and college costs, is the author of "Graduation Debt: How To Manage Student Loans And Live Your Life" and "How Smart Students Pay for School: The Best Way to Save for College, Get the Right Loans, and Repay Debt." She has appeared on PBS's Nightly Business Report and speaks regularly at CollegeWeekLive.