How to Re-Contribute 529 Plan Refunds

By Eric Wetzel, CPA, Tax Associate

Qualified Tuition Programs and COVID-19 Tuition Refunds  

With the COVID-19 related closure of Universities and Colleges throughout the country, many students and parents are receiving partial tuition refunds for unused spring semester room and board.  If these tuition refunds originated from withdrawals of a prepaid 529 education savings plan, also known as Qualified Tuition Programs (QTP), then the taxpayer should recontribute these funds back into the designated beneficiaries’ QTP. If not done within 60 days of refund issuance, and without sufficient documentation to support this re-contribution, taxpayers could encounter a situation in which the IRS determines these refunded amounts as no longer in use for QHEEs, resulting in a 10% penalty, as well as additional income taxes on distribution earnings.

Section 529 defined

As a brief overview, Section 529 of the Internal Revenue Code establishes permission for a state or agency to use a program allowing taxpayers to contribute, or prepay, amounts for a designated beneficiary’s qualified higher education expenses (QHEEs). While each state has at least one 529 plan, with tax benefits for plan contributions varying state by state, all 529 plans share the unique benefit of excluding distributions from taxable income.

Since its inception in 1997, Section 529 continues to receive amendments and clarifications. For instance, Section 529(e)(3)(A) was added specifically to define those QHEEs eligible for tax free distribution: tuition, fees, books, supplies, applicable equipment used in the course of study, and cost for room and board[1]. It was only in 2015, with the passing of the PATH Act (Protecting Americans from Tax Hikes) that Section 529(c)(3)(D) dissolved any ambiguity regarding the tax free treatment of contributing refunds back into the QTP. Of particular relevance to our current circumstance, this amendment clarifies that a distribution refunded to QTP beneficiaries by an eligible educational institution is not subject to income tax, to the extent that the refund is recontributed to a QTP of which that individual is the beneficiary[2], not later than 60 days after the date of such refund, and does not exceed the refunded amount. [i]

How to Re-Contribute 529 plan Refunds

Adhering to guidance offered by your 529 provider regarding re-contributions is an important starting point, as they may outline plan-specific instructions to help you along in the process. However, regardless of the QTP, it is recommended that taxpayers establish a well-documented paper trail to ensure that the nature of the refund and corresponding re-contribution is clear. Writing a letter, with instructions to your plan provider that the payment included shall be characterized as a recontribution of a previous-qualified distribution, solidifies your treatment of these funds. It is important to include the name of the institution in the letter, along with the beneficiary’s name, account number, date and amount of withdrawal from the account that the recontribtuion is designed to fully or partially cover. Also, make sure that the amount you are recontributing to the QTP is the exact amount of the refund, and no greater than. Sending a check, with a memo line describing the nature of the contribution, such as ‘529 plan contribution of 2020 school refund amount’, will complete the paper trail.

In summary, complete the documentation process described above immediately upon receipt of the refund, and store these documents in a safe place. Doing so will place you well within the 60 day re-contribution window, and will prepare you to confront any tax challenges from the IRS further down the road.

If you need specific assistance related to your beneficiary’s 529 refund, or have additional questions about the impacts of COVID-19 on other savings plans, contact your Keiter representative, Email, Call: 804.747.0000.

[1] and was later updated by the Tax Cuts and Jobs Act in 2017 to limit tuition distributions to a maximum of $10,000 to each designated beneficiary

[2] Note the re-contribution does not have to the same QTP from which the withdrawal originally came, but it must be for the same beneficiary.

[i] https://www.irs.gov/pub/irs-drop/n-18-58.pdf

Additional Resources

Read our article, 529 Plans: Benefits and New Tax Incentives, for more 529 plan considerations, including state-specific tax benefits derived from using QTPs for higher education expenses and defined parameters of establishing and contributing to these plans.

For other topics and articles related to COVID-19, visit the Keiter COVID-19 Resources page.

Sources

• Guidance on Recontributions, Rollovers and Qualified Higher Education Expenses under Section 529
• Virginia 529