As Schools Extend Refunds, Potential Tax Snag Emerges - Butler Financial, LTD
Navigating a sea of negativity - June 21, 2022


As Schools Extend Refunds, Potential Tax Snag Emerges

If you receive a refund for expenses paid out of a 529 plan, you may need to take action to avoid negative tax consequences.

As efforts to stem the spread of the coronavirus continue, schools across the world have transitioned away from their lecture halls and embraced digital classrooms. On-campus housing facilities at colleges and universities are closing, and students of all ages are heading back home early to complete their studies.

Many of these institutions have begun to issue refunds to families for amounts unused. However, if you used funds from a 529 plan to pay for those education expenses, the refunded amounts may warrant further consideration.

The tax snag: mismatched amounts

Refunded amounts that were originally paid out of a 529 plan could create a unique tax situation, as payments for tuition, housing, and fees that were once qualified may no longer be considered as such. When a refund is issued, the total amount taken from the 529 plan will likely no longer match the amount of qualified education expenses the student incurred for the year. This mismatch could cause the refunded amount to be considered a nonqualified expense when filing taxes – and it may result in a tax penalty.

The workaround: recontribute the refund

When refunds are issued from a qualified institution, families who used a 529 plan to pay for educational expenses have the option to recontribute the returned payment back into a 529 plan. Recontributing the refunded amount will prevent that portion of the 529 distribution from being considered nonqualified and taxable.

To complete a recontribution, the payment must be deposited back into a 529 plan for the same beneficiary within 60 days of the refund. Note that only the refunded amount is eligible for recontribution into a 529 plan.

Documentation of the recontribution is very important. A receipt for the refunded amount, copies of checks and statements from the 529 plan showing the recontribution purchase should all be retained to ensure accurate recordkeeping. Each 529 plan may have a different process for making a recontribution, so if you have received or will receive a refund, contacting the 529 plan provider is a great place to start.

Your financial advisor can provide specific guidance for your situation and assist you with the recontribution process, and your tax professional can help address additional tax-related concerns.

Investors should carefully consider the investment objectives, risks, charges and expenses associated with 529 plans before investing. This and other information about 529 plans is available in the issuer’s official statement and should be read carefully before investing. Investors should consult a tax advisor about any state tax consequences of an investment in a 529 plan.

Other posts you might like
Translating market moves in challenging times

Markets & Investing July 01, 2022 Where can investors turn when the markets are a riddle? Raymond James...

read more
Live by the numbers, die by the numbers

Economy & Policy July 01, 2022 Chief Economist Eugenio J. Alemán discusses current economic...

read more
Weekly market guide

Markets & Investing July 01, 2022 Review the latest portfolio strategy commentary from Mike Gibbs,...

read more