Financial Planning During a Pandemic: Two Ways to Avoid Tax Consequences from Educational Refunds
If you receive a refund for educational expenses paid out of a 529 plan, you may need to take action to avoid negative tax consequences.
As the Coronavirus pandemic continues to unfold, we’ve seen a shift in the educational landscape from traditional classrooms to at-home and digital platforms. With the mid-semester shutdowns of college and university campuses across the country, many institutions are offering pro-rated refunds on tuition, room and board costs associated with the Spring 2020 semester.
Depending on the initial source for payment, students and their families will need to consider the tax ramifications associated with this type of refund decision. Here, we outline the potential tax consequences and how you can potentially avoid them as it relates to tuition, room and board refunds.
What Are the Potential Tax Consequences Related to Tuition, Room and Board Refunds?
If you used funds from a 529 College Savings Plan account to pay for tuition, room and board expenses, you could be faced with unnecessary tax implications that can be avoided if these expenses are refunded. Since the refund represents funds that are no longer being used for qualified educational expenses, the IRS could recharacterize them as unqualified and taxable distributions. When treated as a taxable distribution, this refund would be subject to a 10% penalty and payment of income taxes on the earnings portion of the distribution (the principal would not be subject to taxes).
How Can You Potentially Avoid the Tax Consequences?
Fortunately, most institutions are offering refund options, and you may choose the scenario that best fits your family situation:
- Apply the refund amount towards the Fall 2020 student bill. If your student will be attending the same institution in the Fall, your simplest option is to apply the refund to their campus student account for future use. Some institutions are even offering an additional percentage credit if you elect to roll your refund over for future semester use (i.e., additional 10% credit of refund amount).
- Recontribute the refund back into the 529 plan. Recontributing the refunded amount will prevent that portion of the 529 distribution from being considered nonqualified and taxable. If you elect to receive a direct refund from the institution, the key to meeting the recontribution requirement is that the refund must be deposited back into a 529 plan for the same beneficiary within 60 days of the refund. Documentation will be essential, so be sure to retain receipts, checks and correspondence related to the recontribution.
Remember, everyone’s situation is different. If you have any additional questions about how educational refunds impact your family, please reach out to your advisor or financial planner for further guidance and assistance or request a member of our team reach out to you.
Ashley Tucker serves as a Financial Planning Associate with Waverly Advisors. Click here to learn more about her or to reach out to her directly.