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, a 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, Wind and other experts offer the following 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."
[See 5 tips for utilizing 529 plan distributions.]
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.
If different estimates are provided in school cost of attendance estimates for on and off campus, families should be able to withdraw up to the limit for the type of housing the student chooses, says Craig Steinhoff, a certified public accountant and personal financial specialist.
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 or 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.
As students are using more e-books, computers and other textbook reading devices are becoming necessary supplies for students, Steinhoff says.
While computers are not specifically stated as being a qualified expense, parents can make a clear argument if audited that it’s a necessity for their son or daughter’s education, he says. However, parents should first use 529 plan funds to pay for items that are clearly stated as allowed: textbooks, tuition and fees and room and board.