Non-qualified withdrawal from NY 529 plan - need help understanding some entries

Forum|Forum|1 year ago
June 23, 2024
1 reply
0 views

For various reasons and after careful thought, I have decided to close down a NY State 529 plan account I have for my child. I have been funding it from 2008 to 2021 for the full amount ($10,000) each year to benefit from the NY state tax deduction (married filing jointly).

Having taken these tax deductions, I do understand that NY State will recover ("recapture") any tax benefits I've received for these deductions from this non-qualified withdrawal as well as tax me on the earnings.

I am using TurboTax 2023 to do a WHAT IF calculation pretending that I withdrew the following amount in 2023.

Amount withdrawn: $26,000
Earnings: $4,000
Basis: $22,000

The Federal portion of the calculation is easy to follow. The earnings of $4000 is added to my income and there is an added penalty of 10% on this.

However, I am having difficulty understanding the NY State calculation shown by TurboTax. I'll use the line numbers of the NY State tax form IT-201 to explain my confusion.

New York additions:
Line 22 (NY 529 college savings plan distribution): $26,000

NY subtractions
Line 30 (NY 529 college savings program deductions/earnings): $4,000

I think I understand Line 30, the NY subtraction from the carried-over Federal income. This removes from NY income the part that was already brought over from the Federal return, which includes this amount as addition to federal income. To have retained it would tax me twice on the same amount. Is my understanding of the Line 30 entry correct?

However, I don't understand Line 22, the NY addition. Why I am being taxed for the full amount withdrawn - is the basis (principal) also being taxed by NY State?

I should mention that I looked at the TT generated NY 529 College Savings Program Worksheet (which is used to populate line 22) and entered in Part II, line 3a $190,000/- as my total contributions to the 529 program from 2008 to 2021, and for which I took a NYS deduction each of those years. I did NOT have ANY non-qualified withdrawals in that period. (This will be my first and only non-qualified withdrawal.)

Please can someone explain the logic used in the worksheet to populate line 22?

Many thanks in advance.

Not A Product Question

Best answer by NCPERSON1

@dyons I can't see how you completed the NYS worksheet, but let me try and explain this way.

1) You were able to deduct $10,000 per year from your NYS tax return for contributions to the 529 plan. That occurred under the presumption that eventually that money would be used for your child's college education.

2) to the extent that you did indeed use the money for college education, there was no tax to be paid (federal or state) when you withdrew the money from the 529 plan.

3) but when you withdraw the money for non-educational purposes, which is what you state occurred, what was tax deductible (the $10,000 per year) now is reversed and is taxable to you.

4) You withdrew $26,000 of which $4000 was the earning component. Federal tax return shows that and that carries to Line 16 on the State Return.

5) now we have to deal with the remaining $22,000. You got the benefit of $10,000 per year as a deduction in return for the promise that the money would eventually be used for college education. Since that promise was compromised, NY State is simply reversing the benefit and saying, you took $22,000 in deductions years ago, well, now that is being reversed and it is $22,000 of income. It is presented as an ADD of $26,000 on Line 22 and then a SUBTRACT of $4,000 on Line 30, the net being the $22,000.

6) Showing the $22,000 as income to you is the 'clawback' for the deduction you took years ago.

7) NYS is showing this in 3 pieces but if you add it all together it is correct: $4,000 ADDED on Line 16, $4000 SUBTRACTED on Line 30 and then $26,000 ADDED on line 22; the net of all three is $26,000 which is what you withdrew from the 529 plan - it is all taxable in NYS to you.

does that help?

NCPERSON1

@dyons if you received a tax deduction from NY over time ($10,000 per year), it would appear the $22,000 (netting the two lines together) is the recapture so it is now taxable to you. Does the $4000 of earnings appear on line 16, carried over from the federal return?

dyonsAuthor

Employee

Thanks for your response and query. I used the TurboTax interview to fill in the 1099-Q, with the numbers I provided and me as the one to whom the distribution is made.

I, too, find $4000 on line 16, because it is taken directly from the federal return to get the Federal AGI, which is then modified by the NY additions and subtractions.

If your program does not give you any entries for lines 22 and 30, it seems as if NY tax is not recovering or clawing back any benefits I derived from getting 10K deductions each year between 2008 and 2021. So, could it be that TaxSlayer is not accounting for NY 529 nonqualified distributions properly?

Thanks for your response.

NCPERSON1

@dyons sorry - I edited my original response as I mis read your query originally. please re-read. Isn't the net $22,000 the recapture and is taxable to you in NYS.