COVID-19, College Housing and 529 Plans
Last month, universities across the country closed their doors and shut down on-campus housing to socially distance and protect students and their families from COVID-19. Many of these universities are now refunding a pro-rata amount of room and board costs. If you paid for on-campus room and board with funds from a 529 plan, and some or all of those payments were refunded by the university due to COVID-19, there are steps you need to take to ensure that the refund isn’t considered a taxable, non-qualified distribution.
Non-qualified distributions are subject to ordinary income tax plus a 10% penalty on the portion of the distribution that represents investment earnings. Fortunately, you have two options to avoid this taxable event.
1. Redeposit the money
The first option is to redeposit, or “recontribute,” the funds back into the 529 plan within 60 days of when the refund was issued. The amount you return to the 529 plan should not exceed the refund amount from the university. If the refund is a check, you have 60 days from the date on the check. If it was refunded by electronic payment, you have 60 days from when the funds were deposited into your account or credited back to your credit card.
If you choose to return the funds to the 529 plan, call the 529 provider to get their plan-specific instructions for how to accomplish this. We recommend that the account owner (usually a parent or grandparent) send a signed and dated letter with the check to the 529 plan. The letter should state:
- The name of the beneficiary and the 529 plan account number
- That the university refunded the payment due to the closure of on-campus housing as a result of COVID-19
- That the payment is a recontribution and not a contribution, and you’re returning the funds within the required 60-day window
- The date and amount of the original 529 distribution, as well as the amount you will be recontributing (the refund will likely be a pro-rata payment)
- The name of the academic institution and the date the refund was issued
Keep a copy of your letter, any letter you received from the academic institution regarding the refund, and a copy of the refund check or a printout of the electronic refund deposit. You will need this documentation if the IRS asks you about the transaction.
2. Spend the money on education
The second option, if the refunded payment was paid to the university in 2020, is to spend the funds on qualified education expenses by the end of the year. Qualified education expenses include:
- Tuition and fees
- Room and board (either on-campus or off-campus as long as enrolled at least half-time and does not exceed the room and board allowance issued by the college)
- Books, supplies and equipment
- Computer or peripheral equipment, educational computer software, or internet access and related services
Be sure to keep a copy of the refund check or printout of the electronic refund, a copy of the university letter (if provided) and receipts for the expenses.
If the room and board funds were paid to the university in 2019, then the refund cannot be spent in 2020 or it will be considered a taxable, non-qualified withdrawal. In this instance, you should redeposit the funds to your 529 plan as outlined above.
Your 529 provider will issue an annual tax form 1099-Q, which reports the total distributions received in 2020. It also reports what percentage of the distribution represents principal vs. earnings. The form doesn’t specify which distributions were used for qualified vs. non-qualified expenses. The 1099-Q is sent to the IRS, but you don’t need to file it with your tax return. Remember the following:
- If you recontribute the housing refund to the 529 plan, the returned funds will not be reflected on the 1099-Q. In this case, be sure to keep both the 1099-Q along with paperwork documenting your returned refund.
- If you use the refund to cover other qualified educational expenses in 2020, be sure to maintain both the 1099-Q along with paperwork documenting the additional expenses.
- If you spend the refund on non-qualified educational expenses, the earnings on that amount should be reported as taxable income (with a 10% penalty) in 2020.
Every situation is unique, so be sure to consult your investment advisor or tax accountant for guidance specific to you.