Don’t get schooled: Handling tuition refunds from 529 plans

While universities, parents and students weigh the risk of returning to campus life this fall, many petitioning for a spring-semester refund could find themselves facing an unexpected tax bill.

The sudden onset of the COVID-19 pandemic turned once-bustling residence halls, quads and classrooms into ghost towns overnight. Many parents and students upset with footing a bill for services they could no longer use – meal plans and housing, for example – have voiced their frustrations in the form of class-action lawsuits against universities.

While some schools are not budging, others are conceding and devising plans to pay families back. For those who made the original tuition payments with 529 college savings accounts, the welcome news could come with a tax bite if you are not careful.

The refunded money must be put back into the 529 plan within 60 days or spent on other qualified expenses (tuition, fees, room and board, books, computers, software and internet) in the same calendar year or it could result in a non-qualified distribution, triggering a 10% tax penalty in addition to income taxes on the account’s earnings. Making matters worse, if you received a state income-tax deduction on the contribution you could be on the hook and forced to repay the tax breaks you received.

If you anticipate additional qualified expenses this year, instead of putting the money back into the 529 plan you could simply reduce the amount you withdraw from the 529 plan for fall expenses by the refund amount, so that for the full calendar year the qualified expenses (net of any refunds) do not exceed the 529 plan withdrawals.

If you do not anticipate additional qualified expenses this year, the refunded dollars should be deposited back into the plan quickly. The full specifics behind the ruling are as follows: In response to the pandemic, the IRS issued a notice giving account owners who received refunds prior to May 15th until July 15th to redeposit the funds in a 529 account. Those who received refunds after May 15th have 60 days from the date of the refund. If you wait past July 15th or longer than 60 days to deposit the money back into your 529, it will be considered a new contribution and the tax penalty will still apply. The contribution also will count toward annual exclusion gifts for the year, which potentially could put you over the annual gifting limit.

The money does not need to go back to the same 529 plan that the original withdrawals were taken from, but it must go back into a plan with the same beneficiary.

The 529 account owner is responsible for making sure all transactions meet the IRS requirements to avoid possible tax consequences. Additionally, it is important to keep statements and a paper trail.

A tuition refund is good news – just be sure not to celebrate so much that you drop the ball after receiving it.

The material shown is for informational purposes only and should not be construed as accounting, legal, or tax advice.  Altair Advisers LLC is a registered investment adviser with the Securities and Exchange Commission; registration does not imply a certain level of skill or training.  While efforts are made to ensure information contained herein is accurate, Altair Advisers cannot guarantee the accuracy of all such information presented.