529 plan

What You Need to Know About 529 Plan Withdrawals

The big advantage of Section 529 college savings plans is that withdrawals used to cover qualified higher education expenses are free from federal income tax (and usually state income taxes too). That part is very easy to understand, but the full story on withdrawals is not so simple. What are qualified expenses? What happens if you take out money for expenses that aren’t qualified?

Here are five important facts that you should know about 529 plan withdrawals:

Fact #1: You Have Two Basic Payment Options

  • You can direct the plan to make a withdrawal check out in the name of the account beneficiary (meaning the student for whom the account was set up, usually your child or grandchild).
  • You can direct the plan to make a check out in your name as the account owner or plan participant (meaning the person who established and funded the account).

Assuming the withdrawn funds will be used for the benefit of the account beneficiary (to pay for his or her college costs or for whatever other reason), having the check made out to him or her is the recommended option. If the money will be spent on college costs, you can have the beneficiary endorse the check over to you so you can control the spending.

If you as the account owner will keep the withdrawn funds for your own benefit, having the check made out in your name is the recommended option.

Handling withdrawals in this fashion makes it easier to “follow the money” for tax purposes.

Beware: As a matter of state law, you’re not permitted to keep a withdrawal from a 529 account that was funded with money from a custodial account established for the 529 plan beneficiary (your child or grandchild) under a state’s Uniform Gift to Minors Act (UGMA) or Uniform Transfer to Minors Act (UTMA). In this case, the money in the custodial account belongs to the kid, and the money in the 529 account does too because it came from the custodial account. In other words, a 529 account that was funded with custodial account money belongs to the child for whom the custodial account was set up. Therefore, withdrawals must be used for the benefit of the child, and not for your own purposes.

On the other hand, if you funded the 529 account with your own money, you can take withdrawals and do whatever you want with them because it’s your money. Just make sure you understand the tax implications.

Fact #2: The IRS Knows About Withdrawals

When a withdrawal is taken from a 529 account, the plan is supposed to issue a Form 1099-Q, Payments From Qualified Education Programs, by no later than February 1 of the following year.

If withdrawal checks were issued to the account beneficiary, the 1099-Q will come to the beneficiary with his or her Social Security number on it. If checks were issued to you as the account owner, you will receive the form with your Social Security number on it.

Line 1 of the 1099-Q shows the total withdrawn for the year. Assuming the account made money, withdrawals will include some earnings and some tax basis from contributions.

  • Withdrawn earnings are shown on line 2 of the 1099-Q. They may or may not be tax free.
  • Withdrawn basis amounts are shown on line 3. They are always free of any federal income taxes or penalties.

The IRS gets a copy of the Form 1099-Q, so the government knows withdrawals were taken and who received them.

Fact #3: Some Withdrawals May Not Be Tax-Free, Even in Years with Big College Expenses

When the 1099-Q shows withdrawn earnings, the IRS might become interested in looking at the recipient’s Form 1040, because some or all of the earnings might be taxable. Here’s how the tax rules work.

Withdrawn earnings used for the benefit of the account beneficiary are always federal-income-tax-free when total withdrawals for the year do not exceed what the IRS calls the adjusted qualified education expenses, or AQEE, for the year. These expenses equal:

  • The account beneficiary’s tuition and related fees for an undergraduate or graduate program;
  • Room and board (but only if he or she carries at least half of a full-time load); and
  • Books and supplies, computer and Internet access costs.

Once you add up the above costs, then subtract:

  • Costs covered by Pell grants, tax-free scholarships, fellowships, tuition discounts and veterans’ educational assistance;
  • Costs covered by employer-provided educational assistance or any other tax-free educational assistance (not including assistance received by a gift or inheritance);
  • Expenses used to claim the American Opportunity or Lifetime Learning tax credit; and
  • Expenses used to claim the tax deduction for college tuition and fees.

When withdrawals exceed adjusted qualified education expenses, all or part of the withdrawn earnings will be taxable. This little-known fact is an unpleasant surprise for some people.

Example: Ben has $36,000 in college expenses. He receives $24,000 in tax-free scholarships and tuition discounts, so his adjusted qualified education expenses are only $12,000. His parents arrange for a $36,000 withdrawal from Ben’s 529 account. Assume the withdrawal includes $6,000 in earnings. The parents use the money to cover the $12,000 of qualified education expenses, plus Ben’s clothing, pizza, and other incidentals, as well as a car for him to get back and forth to school. Since the $12,000 of adjusted qualified education expenses are only one-third of the 529 withdrawal, only one-third of the withdrawn earnings, or $2,000, is tax free. The remaining $4,000 is taxable and should be reported on the miscellaneous income line of Ben’s Form 1040. Depending on Ben’s overall tax situation and whether the Kiddie Tax applies to him, the tax hit on the $4,000 may or may not be a significant percentage. (The $4,000 of taxable earnings Ben receives counts as unearned income for purposes of the Kiddie Tax rules.)

Tax-wise steps: The parents should direct the plan to issue the withdrawal check in Ben’s name rather than their names. Then, the parents should have Ben endorse the check over to them so they can control the spending. That way, Ben will be issued the 1099-Q and will bear the tax consequences.

Example: This time, assume Ben has $36,000 in adjusted qualified education expenses because he doesn’t receive any scholarships or tuition discounts. Since his qualified expenses do not exceed the amount taken from his 529 account, the withdrawn earnings are federal-income-tax-free. Therefore, the $6,000 is not reported on Ben’s Form 1040.

Fact #4: You Can Usually Keep Withdrawals for Yourself — But there May Be Taxes

Assuming the 529 account was funded with your own money (as opposed to money from your child’s custodial account), you are free to change the account beneficiary to yourself and take federal-income-tax-free withdrawals to cover your own qualified education expenses if you decide to go back to school.

Earnings included in withdrawals that you choose to use for purposes other than education must be included in your gross income and will probably be hit with a 10 percent penalty (explained below).

However, if you liquidate a 529 account that is worth less than you contributed (because of the stock market), there won’t be any withdrawn earnings, so you won’t owe anything to the IRS. You might even be able to claim a tax-saving write-off for your loss.

Fact #5: Withdrawals Not Used for Education Can Be Hit with a Penalty

As explained earlier, the earnings included in 529 account withdrawals that are not used to cover the account beneficiary’s qualified education expenses must be included in gross income. In other words, the earnings are taxable. But there’s more.

According to the general rule, taxable earnings are also hit with a 10 percent penalty tax. However, the penalty tax does not apply to earnings that are only taxable because the account beneficiary’s adjusted qualified education expenses were reduced by Pell grants, tax-free scholarships, fellowships, tuition discounts, veterans’ educational assistance, employer-provided educational assistance or any other tax-free educational assistance (other than assistance received by gift or inheritance), or costs used to claim the American Opportunity or Lifetime Learning tax credit. In addition, the penalty tax doesn’t apply to earnings withdrawn because the beneficiary attends one of the U.S. military academies (such as West Point, Annapolis or the Air Force Academy). Finally, the penalty doesn’t apply to earnings withdrawn if the account beneficiary dies or becomes disabled.

Example: Dave has a falling out with his daughter, who decides not to go to college. Dave liquidates her 529 account, which he funded with his own money, and uses the withdrawal to buy an expensive new car for himself. Assume the 529 withdrawal includes $8,000 of earnings. Dave must report the $8,000 as miscellaneous income on his Form 1040. In addition, he will be socked with the 10 percent penalty tax on the $8,000.

Section 529 plans are one of the most popular ways to save for college. But in addition to knowing the rules for making contributions, it’s important to understand how you can get money out of a 529 plan with the best possible tax outcome. If you have questions, consult with your tax adviser.

© Copyright 2016.


Choosing the right legal form for your business

Choosing the appropriate legal form for a business is one of the first issues most entrepreneurs face. It is an important decision at the formation stage and also as a business grows. Sole proprietorships are generally the easiest. Corporations offer some different advantages, but often with additional complexity.

This article addresses some of the pros and cons of different types of legal structures for businesses. Even if your enterprise has been in existence for a while, it may be time to review your options. There can be many complexities in determining the best legal structure and a qualified attorney may be of value when evaluating your choices.

At a minimum, consider the following issues when evaluating the business structure decision:

  • Number of owners;
  • Personal liability of owners;
  • Tax treatment;
  • Control and management; and
  • Capital contributions.

Here is a chart that provides some of the basic information to consider.

Business Structure Alternatives
Issues to ConsiderSole ProprietorshipC Corporation (Regular Corporation)S Corporation (Sub-chapter S Corporation)General PartnershipLimited PartnershipLimited-Liability Company (LLC)
Ownership RulesOne owner.Unlimited number of shareholders with no limit on the classes of stock.Up to 100 shareholders are allowed. Only one class of stock is allowed.Unlimited number of general partners.Unlimited numbers of general and limited partners are allowed.Unlimited numbers of “members” are allowed.
Liability of OwnersUnlimited liability for obligations of the business.Generally, no personal liability for obligations of the corporation.Generally, no personal liability for obligations of the corporation.All general partners are fully liable for obligations of the business.Unlimited liability for the general partners and no personal liability for the limited partners.Generally, no personal liability for obligations of the entity.
Tax TreatmentEntity is not taxed, all income and losses passed through to owner.Corporation is taxed at the corporate level. Shareholders are taxed on any dividends received.Entity is not taxed; profits and losses are passed through to the shareholders.Entity is not taxed, all income and losses passed through to partners.Entity is not taxed; profits and losses are passed through to the general and limited partners.Entity is not taxed; profits and losses are passed through to the members.
Control and ManagementSole proprietor manages the business.Board of Directors has overall management responsibility with officers having day-to-day responsibility.Board of Directors has overall management responsibility with officers having day-to-day responsibility.General partners have equal management rights unless they decide otherwise.General partner manages the business subject to the Limited Partnership Agreement.The Operating Agreement describes how it to be managed. A Manager is usually designated to manage the business.
Capital ContributionsSole proprietor makes any capital contributions as needed.


Shareholders usually buy stock in the corporation. Corporation can issue common and preferred stock.Shareholders usually buy stock in the one class of stock issued by the corporation.General partners contribute money or services to business and receive interests in profits and losses.Both general and limited partners contribute money or services and receive interests in the profits and losses.The members typically contribute money or services to the LLC and receive an interest in the profits and losses.
Ease of EstablishingEasiest.Must file Articles of Incorporation with the Secretary of State.Must file Articles of Incorporation with the Secretary of State.No filing. But a partnership agreement is needed.File an application with the Secretary of State.File Articles of Organization with the Secretary of State.

© Copyright 2016.


Anticipate Future Possibilities with a Shareholders Agreement

A shareholders agreement drafted for a privately held company details the rights and obligations of the shareholders. It not only provides guiding principles for running the business today, it lays out the ground rules of what to do if one of the shareholders dies, becomes disabled — or one party wants to dissolve the business.

In other words, it can resolve issues in the future that you may not even anticipate now.

Caution: There are online shareholders agreement templates that can be filled in. But there is no one-size-fits-all shareholders agreement that is applicable to all businesses. Your company is unique and the terms of your shareholders agreement must reflect that. In addition, it must comply with the laws of the state where it is being drafted and be in compliance with SEC regulations.

A shareholders agreement can be a complex document. Here are just some of the questions your attorney may ask when drafting one.

What is the basic information about the business and the shareholders?
  • The name, address and state of incorporation of the business.


  • The names and addresses of all shareholders who are parties to the agreement.


  • The number of shares each shareholder will own.
How will transfers of shares be handled?
  • Can shareholders transfer shares to family members?


  • Must the company or other shareholders be given the right of first refusal to purchase them?


  • Must shareholders approve any transfer?
What about the sale of shares?
  • Must the company or other shareholders be given the right of first refusal to purchase them?


  • Can shareholders sell some shares or must all shares be sold?


  • Can shares be sold to a third party?
How is each share valued?
  • What is the present value of each share?


  • Is the price based on book value, fair market value based on the company’s assets and liabilities or another method?
What will happen if a shareholder dies?
  • Will a shareholder’s shares be sold only after the business or other shareholders have the first election to purchase them?


  • Will there be life insurance to pay for the shares?
What happens if a shareholder becomes disabled?
  • Will a disabled shareholder’s shares be sold only after the business or other shareholders having the first election?


  • Will there be disability insurance to pay for the shares?


  • How will you define “disability?”
What about new shares?
  • Is the issuance of new shares prohibited?


  • If not, must shareholders be offered new shares in proportion to their interests so they won’t be diluted?
How will disputes be handled?
  • Must they be resolved by arbitration?
What about spouses?
  • What restrictions will be placed on the ability of shareholders to transfer shares to a spouse?


  • Do spouses have the right to vote?


  • What about in the case of divorce?
What limitations will be placed on shareholders’ ability to compete — especially if they sell shares or leave the business?
  • How will the scope of a non-compete clause be defined? For example, how long will it last and what geographic area will be covered?


  • Can shareholders be involved in other businesses that may potentially compete with the company?


  • Is there a non-solicitation clause that prohibits shareholders or former shareholders from hiring employees (or independent contractors) to work for another competing business?
Will there be a board of directors?
  • Who can serve?


  • What are their duties and roles?
How will contributions be handled?
  • What is the amount of initial contribution?


  • How will future capital contributions be made?


  • How will capital contributions be paid back?
When will the shareholder agreement terminate?
  • Will it end when all shareholders agree to it?


  • Will it stay in effect until a specific date?


  • What if some of the shareholders want to sell the business but the others don’t?

This article only covers some of the issues that could be covered in a shareholders agreement. The exact provisions will depend on the shareholders and they type of business. By having an agreement, you can help avoid contentious, expensive disputes in the future and help protect the rights of all shareholders.

Note: The attorney drafting the agreement is representing the company. Each of the shareholders should be advised to consult with an attorney to protect their individual interests.

© Copyright 2016.