Coverdell Education Savings Accounts | Wolters Kluwer
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  • Coverdell Education Savings Accounts - Tax-Free Distributions for Qualified Education Expenses

    DianaTheis Onward

    by Diana Theis, Consultant, Tax Advantaged Accounts, Wolters Kluwer

    Published July 13, 2017




    Overview

    Coverdell Education Savings Accounts (CESAs) were introduced under the Taxpayer Relief Act of 1997. Since their creation, many parents, grandparents, and others have established and funded CESAs to help pay for the qualified educational expenses of a designated beneficiary. A CESA distribution is tax free if the funds are used to pay for qualified education expenses incurred by the designated beneficiary the same year he or she is enrolled as a student at an eligible educational institution.

    Qualified Education Expenses

    Many designated beneficiaries are now attending colleges and universities and using CESA assets tax-free to help pay their educational expenses. However, CESA assets can also be used to pay qualified elementary and secondary education expenses.

    Qualified elementary and secondary education expenses include:

    • Tuition, fees, academic tutoring, special needs services for a special needs-designated beneficiary, books, supplies, and required equipment
    • Computer technology, equipment, and internet access and related services used by the designated beneficiary or his/her family during any of the years the beneficiary is in school
    • Reasonable room and board
    • Uniforms
    • Transportation
    • Supplementary items and services (including extended day programs)

    Qualified higher education expenses include:

    • Tuition, fees, books, supplies, and required equipment
    • Special needs services for a special needs-designated beneficiary
    • Computer-related expenses used by beneficiary during the years enrolled at an eligible educational institution including:
      • Purchase of computer or peripheral equipment
      • Computer software, and
      • Internet access and related services
    • Room and board for students attending on an at least half-time basis

    Eligible Educational Institution

    Eligible educational institutions are either elementary or secondary institutions, or higher education institutions.

    An eligible elementary or secondary educational institution is any school that provides elementary or secondary education (K through 12) as determined under state law. This includes public, private, or religious schools.

    An eligible higher education institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in the student aid program administered by the U.S. Department of Education (DOE). This includes virtually all accredited public, nonprofit, and proprietary (privately owned for profit) postsecondary educational institutions.

    An educational institution should be able to inform a designated beneficiary and/or responsible individual if it is an eligible educational institution for CESA distribution purposes.

    Qualified Tuition Program Contributions

    A CESA distribution that is subsequently used to fund a qualified tuition program (QTP) is also a qualified education expense. Distributions from a CESA that are used to fund a QTP are often referred to as transfers. However, this transaction is a reportable distribution from the CESA, and the deposit into the QTP, via transfer or otherwise, is a qualified education expense.

    Non-Qualified CESA Distributions

    The earnings portion of a CESA distribution not used to pay or reimburse an eligible expense, or not taken in the year an otherwise eligible expense was incurred, is subject to federal income tax and a 10 percent penalty tax. Each distribution is a pro rata combination of nontaxable contributions and earnings.

    Internal Revenue Service (IRS) Publication 970, Tax Benefits for Education provides several work sheets to help a responsible individual determine the taxable portion of the year’s CESA distributions. This publication is available at the IRS web site, www.irs.gov.

    Mandatory Distribution at Age 30

    The rules require a designated beneficiary use CESA assets in full prior to age 30. Any balance remaining in a CESA on the date the designated beneficiary reaches age 30 must be distributed to the designated beneficiary within 30 days. If not distributed within 30 days the balance is deemed distributed as of that date.

    If allowed by the CESA agreement, the responsible individual may transfer the CESA balance to a member of the current designated beneficiary’s family, if such individual is younger than age 30. This allows a CESA to maintain its tax deferred status and continue to be used tax-free for qualified educational expenses.

    The age 30 distribution requirement does not apply to a designated beneficiary with special needs.

    Who Authorizes a CESA Distribution?

    As many designated beneficiaries are minor children, the authority to sign for a CESA distribution typically falls on the shoulders of the responsible individual, generally a parent or legal guardian of the designated beneficiary. However, an optional provision election can be made by the individual that establishes a CESA specifying that the designated beneficiary will become the responsible individual upon age of majority allowing him or her to independently request distributions at that age. Therefore, when a designated beneficiary has reached the age of majority, a custodian/trustee will need refer to the optional provision section of the CESA Application and agreement to determine who is authorized to sign for distributions as well as control CESA activity.

    Documenting and Reporting CESA Distributions

    A CESA custodian/trustee documents distributions on a CESA distribution form. Generally, all distributions, whether used for qualified educational expenses or not, are considered normal distributions. Generally, all CESA distributions are reported on IRS Form 1099-Q, Payments From Qualified Education Programs (Under Section 529 and 530), in the name and tax identification number of the designated beneficiary. For detailed information on how to report using Form 1099-Q, see the Instructions for Form 1099-Q.

    Conclusion

    It is not a custodian/trustee’s responsibility to verify whether a distribution is being used for a qualified educational expense. The responsible individual plays an important role in managing a CESA. It is his or her responsibility to ensure the CESA is used properly, allowing distributions to be tax free.

    Further information on Coverdell Education Savings Accounts can be obtained from the Internal Revenue Service. To obtain a copy of IRS Publication 970, Tax Benefits for Higher Education, go to the IRS website at www.irs.gov.

    For an opportunity to learn more about IRAs and other tax-advantaged accounts, including Health Savings Accounts and Coverdell Education Savings Accounts, consider joining us for one of our Live Streaming events offered on a variety of topics. Learn more on training opportunities available to you, or you can call us at 1-800-552-9408.



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