How does TurboTax handle 529 withdrawals that are: 1. Not for educational purposes, but 2. Not penalized because the plan beneficiary attends a US Service Academy?

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June 28, 2020
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How does TurboTax handle withdrawals from 529 Plans that are: (1) not for educational purposes, but (2) not subject to the 10% tax penalty because the plan beneficiary is (a) attending a US Service Academy, and (b) the amount withdrawn does not exceed the cost of advanced education? Statutory references are:
26 USC 529(c)(6)
26 USC 530(d)(4)(B(iv))
10 USC 2005(d)(3)

TurboTax Online

Best answer by Hal_Al

To go even further with this and the distinctions between the academies:

A. To be an "eligible school" IRS says to look at either the DOEd accreditation list or the DOEd's student aid list. See https://www.irs.gov/credits-deductions/individuals/earned-income-tax-credit/eligible-educational-inst.

B. The two DOEd lists are different. While all service academies are on the accreditation list, only USMMA is on the student aid list.

Apparently, USMMA is a college, for educational tax benefits. So, the out of pocket book expenses are eligible for a credit or deduction.

In TurboTax (TT), enter at:

Federal Taxes Tab (Personal for H&B version)

Deductions & Credits

-Scroll down to:

--Education

--Education Expenses

After answering no to the getting a 1098-T question, answer yes to qualifying for an exception. That will get you the screens to enter expenses.

Hal_Al

Employee

The earnings portion of the distribution is reported as taxable income on line 8 of Schedule 1. On form 5329, TurboTax (TT) will enter the taxable amount on line 5 and subtract the same amount on line 6, so that the amount subject to the 10% penalty (on line 7) is zero.

The 1099-Q interview, in TT, will ask if the beneficiary attended a service academy.

In TurboTax (TT), enter at:

Federal Taxes Tab (Personal for H&B version)

Deductions & Credits

-Scroll down to:

--Education

--ESA and 529 Qualified Tuition Programs (1099-Q)

When asked "Who's the student", do NOT check "the distribution was not used to pay any education expenses. If the cadet is not listed as a dependent, on your return, select "Someone else not listed here". Leave the educational expenses boxes empty.

jadcomAuthor

Thanks. I will review in greater detail, but let me ask this follow-up.

Students at service academies still incur expenses that would be qualified expenses for 529 purposes, like books, uniforms, and computers. Are these expenses entered in a dialogue or directly on the worksheet? I am looking at the 2020 worksheet called "Payments from Qualified Education Programs (Under Sections 529 and 530)." Under the section called "Qualified Tuition Program (QTP) Computation of Taxable Distribution," I see that line 2.c. provides for "Adjusted Qualified education expenses attributable to this QTP." Should I override this line ($0) with the amounts I withdrew to cover the computer, uniforms, books, etc.?

DawnC

Employee

They (books, uniforms, and computers) are entered into a dialogue box in the Education Expense section. It goes on the screen titled Did you pay for Books or Materials to Attend school? which is part of the 1098-T interview. Make sure you have already entered your 1099-Q. And after you go through the 1098-T interview and enter any deductible expenses, you will be able to review your entries. When you review your entries, the first screen will say ''Let's get your additional Education Expenses''. Click continue, and you will get the screen below. 'Room and Board' is highlighted, but use whatever category is appropriate for the expense.

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Macdojo70

Student received a distribution from a 529 account during 2023 at which time the student was enrolled in a US Military academy. Understanding is that attendance at a service academy is an exception to the 529 withdrawal 10% penalty, however Turbo tax continues to calculate a 10% penalty although the Student Information worksheet notes in box 2 that the individual attended a Service academy as box "e -military academy is selected". How can the 10% penalty being calculated be removed as this distribution is an exception to the 10% penalty.

DMarkM1

Yes, the 10% additional penalty for withdrawal of 529 earnings not used for education expenses by a military service academy student/designated beneficiary is waived. TurboTax does remove the 10% penalty in desktop and online versions. You should check Schedule 2, line 8 to verify there is no penalty being applied. You can use "Forms Mode" in desktop products or the following steps for online versions to "Preview your form 1040".

1. Select "Tax Tools" in the left hand menu
2. Select "Tools"
3. Select "View Tax Summary"
4. Select "Preview My 1040" in the left hand menu

5. Scroll down to the Schedule 2, line 8

If you have a desktop product you can also use "Forms Mode" to check form 5329 to verify the Smart Worksheet for line 6 shows the distribution as not subject to the additional tax.

If the penalty is showing up on those forms then revisit the education topic and verify your entries.

In the Education 529 topic after verifying the form information, "uncheck/recheck" the service academy selection.

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Hal_Al

Employee

Check your form 5329. I tried it in my desktop Deluxe. Although the 1099-Q worksheet appears to be calculating the penalty amount, form 5329 properly applies the penalty exception on lines 7 & 8 (see the smart worksheet above line 7)