Having tax documents and other paperwork related to tax-advantaged college investment accounts ready at tax time helps families prove their withdrawals and contributions in case of state or federal tax audits.
In the case of withdrawals from these accounts, commonly known as 529 plans, families have to prove the money went to pay for qualified education expenses such as textbooks or tuition to avoid tax penalties.
California parents Jerry and Shawna Straw are waiting for their 529 plan 1099-Q, the tax document that shows all withdrawals and transfers between plans, says Deborah Fox, owner of Fox Financial Planning Network.
Families should look for three key pieces of information on the 1099-Q, Fox says. Box 1 reports all distributions and withdrawals for the year. Box 2 is the portion that came from earnings. Box 3 is original contributions, she says.
The other tax form families need is the 1098-T, the form a school sends that shows both scholarships received and money paid. The Straws already received theirs, and the amount of tuition paid helps prove that the Straws used 529 plan savings toward their son’s college tuition.
The other paperwork parents need on hand are receipts or check copies for contributions.
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Families in states that offer state tax deductions for college savings contributions need to save evidence of the contributions they made, says Susan Howe, a Pennsylvania-based certified public accountant.
The exact proof used depends on how the contribution was made. If the family paid by check, she suggests a photocopy of the check. If the contribution was paid online, through a bank bill payment system or directly to the 529 plan, the contributor should print a screen image that shows the payment.
Printing copies will help families keep track of 529 plan distributions in two ways: who made the contribution and what year the payment was made, Howe says.
Depending on the state, other people who contribute to a child’s 529 account can get tax deductions whether or not they own the account, she says.
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Saving copies of contribution payments also verifies the date the payment was made. The payment date is important because families need to only claim payments that meet the guidelines for the allowed dates for their state.
Many states allow families to claim contributions made by Dec. 31, but some states allow contributions made as late as April 15 of the following year to be claimed.
Parents should also save distribution receipts, Howe says. While tuition and other payments are made directly to the university, parents also need to show proof for other expenses, such as off-campus housing or textbooks.
Money withdrawn for participation in sports clubs and extracurricular activities or insurance costs may incur tax penalties. However, if insurance is required by the university, 529 plan money may not be subject to a penalty.
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Fox also says the following three activities will also cause tax penalties: paying college expenses in a separate year than the money was withdrawn from a 529 plan, withdrawing money before the minimum time the funds are required to stay in the account and changing beneficiaries on an account to a nonfamily member.
An example of paying for something in a separate year than the withdrawal is if a family took money out of the account in December to pay January’s tuition, she says.
According to the College Savings Plans Network, family members include: natural or legally adopted children, parents or ancestors of parents, siblings or stepsiblings, stepchildren, stepparents, first cousins, nieces or nephews and aunts or uncles – as well as their spouses, and the spouse of the beneficiary.
When in doubt on tax rules, experts recommend families consult a financial professional, read the state 529 plan website and check with their 529 plan manager.
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