7.25.44  Qualified Tuition Programs

7.25.44.1  (10-01-2005)
Overview

  1. IRC 529 was added to the Internal Revenue Code by section 1806 of the Small Business Job Protection Act of 1996, Public Law 104-188, 110 Stat. 1895. IRC 529 was modified by sections 211 and 1601(h) of the Taxpayer Relief Act of 1997, Public Law 105-34, 111 Stat. 810 and 1092. IRC 529 was further modified by section 402 of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA 2001), Public Law 107-16, 115 Stat. 60. Portions of IRC 529 may be affected by section 901 of EGTRRA 2001 (the sunset provision), 115 Stat. 150.

  2. IRC 529 provides an exemption from federal income tax for qualified tuition programs described in IRC 529.

  3. Qualified tuition programs are subject to the unrelated business income tax of IRC 511. However, an interest in a qualified tuition program shall not be treated as debt for purposes of IRC 514.

  4. IRC 529(c) in general, and (c)(2) and (c)(5) in particular, provide special rules relating to the gift tax treatment of contributions, distributions, changes in designated beneficiaries, and other transfers of qualified tuition program interests.

  5. IRC 529(c)(4) provides special rules relating to the estate tax consequences applicable to a contributor to or a designated beneficiary of a qualified tuition program.

7.25.44.2  (10-01-2005)
Qualified Tuition Programs

  1. A qualified tuition program is a program established and maintained by a State, or an agency or instrumentality of a State, or by one or more eligible educational institutions. The program must meet other requirements described in IRC 529.

  2. Under a qualified tuition program, a person may purchase tuition credits or certificates on behalf of a designated beneficiary which entitle the beneficiary to the waiver or payment of qualified higher education expenses. This type of program may also be called a "prepaid" qualified tuition program.

  3. In the case of a program established and maintained by a State, or an agency or instrumentality of a State, a person may make contributions to an account which is established for the purpose of meeting the qualified higher education expenses of the designated beneficiary of the account. This type of program may also be called a qualified tuition "savings" program.

  4. A qualified tuition savings program may not be established and maintained by one or more eligible educational institutions.

  5. A program established and maintained by one or more eligible educational institutions shall not be treated as a qualified tuition program unless the program provides that amounts are held in a qualified trust. A qualified trust means a trust which is created or organized in the United States for the exclusive benefit of designated beneficiaries and with respect to which the requirements of IRC 408(a)(2) and (5) are met.

  6. A program established and maintained by one or more eligible educational institutions must receive a ruling or determination from the Internal Revenue Service that the program meets the applicable requirements of IRC 529.

  7. The following qualification requirements are applicable to any type of qualified tuition program:

    1. Contributions and purchases must be made only in cash;

    2. Separate accounting must be provided for each designated beneficiary;

    3. Neither the contributor nor designated beneficiary may, directly or indirectly, direct the investment of any contributions or earnings on the contributions;

    4. No interest in the program, or any portion of an interest, may be used as security for a loan; and

    5. There must be adequate safeguards to prevent contributions exceeding the amount necessary to provide for the qualified higher education expenses of the beneficiary.

  8. Notice 2001-55, 2001-2 CB 299, provides additional guidance with respect to the requirement in (7)c above. Neither the contributor nor the designated beneficiary may, directly or indirectly, direct the investment of any contributions or earnings on the contributions. However, a program may permit a change in the investment strategy selected for an account once per calendar year, and upon a change in the designated beneficiary of the account. The program must establish procedures and maintain records to prevent a change in investment options from occurring more frequently than once per calendar year or upon a change in the designated beneficiary of the account. In addition, a program must allow participants to select only from among broad-based investment strategies designed exclusively by the program. The notice provides that qualified tuition programs and their participants may rely on Notice 2001-55 pending the issuance of final regulations under IRC 529.

7.25.44.3  (10-01-2005)
Definitions

  1. There are several important terms, the meaning of which may be unique to IRC 529, including:

    • designated beneficiary;

    • member of the family;

    • qualified higher education expenses; and

    • eligible educational institution.

7.25.44.3.1  (10-01-2005)
Designated Beneficiary

  1. A designated beneficiary is the individual designated at the commencement of participation in the qualified tuition program as the beneficiary of amounts paid (or to be paid) to the program.

  2. In the case of a change of beneficiaries, it is the new beneficiary.

  3. In the case of an interest in a qualified tuition program purchased by a State or local government, or an agency or instrumentality thereof, or an organization exempt from taxation under IRC 501(a) and described in IRC 501(c)(3) as part of a scholarship program operated by such government or organization, the individual receiving such scholarship interest is the beneficiary.

7.25.44.3.2  (10-01-2005)
Member of the Family

  1. The term "member of the family" means with respect to any designated beneficiary:

    1. the spouse of such beneficiary;

    2. an individual who bears a relationship to such beneficiary which is a relationship described in subparagraphs (A) through (G) of IRC 152(d)(2);

    3. the spouse of any individual described in the preceding clause b; and

    4. any first cousin of such beneficiary.

7.25.44.3.3  (10-01-2005)
Qualified Higher Education Expenses

  1. The term "qualified higher education expenses" means tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution.

  2. Expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with such enrollment or attendance are also qualified higher education expenses.

  3. Qualified higher education expenses also include certain room and board expenses for an eligible student (defined in IRC 25A(b)(3)) who attends an eligible educational institution. Generally, an eligible student is a student who attends at least half time as determined by the institution. The amount of room and board treated as qualified higher education expenses may not exceed –

    1. the allowance applicable to the student for room and board included in the cost of attendance, defined in section 472 of the Higher Education Act of 1965 (20 USC 1087ll) as in effect on June 6, 2001 (the date of enactment of EGTRRA 2001) as determined by the eligible educational institution for such period; or

    2. if greater, the actual invoice amount the student residing in housing owned or operated by the eligible educational institution is charged by such institution for room and board costs for such period.

7.25.44.3.4  (10-01-2005)
Eligible Educational Institution

  1. The term "eligible educational institution" means an institution described in section 481 of the Higher Education Act of 1965 (20 USC 1088) as in effect on August 5, 1997, and which is eligible to participate in a program under Title IV of the Higher Education Act of 1965. This definition may include some foreign institutions and proprietary institutions.

7.25.44.4  (10-01-2005)
Tax Treatment of Designated Beneficiaries and Contributors

  1. Any distribution, whether in cash or in-kind, under a qualified tuition program, is includible in the gross income of the distributee in the manner as provided by IRC 72 to the extent not excluded from income under another part of the Code. For purposes of IRC 529, each distribution consists of basis and earnings (if any).

  2. Part or all of the earnings portion of a distribution may be excluded if the distribution was used to pay qualified higher education expenses. This exclusion applies to distributions made after December 31, 2001, if the distribution was made from a qualified tuition program established and maintained by a State, or an agency or instrumentality of a State; or after December 31, 2003, if the distribution was made from a qualified tuition program established and maintained by one or more eligible educational institutions. This exclusion expires for distributions after December 31, 2010, with sunset of EGTRRA 2001.

  3. If a distribution from a qualified tuition program is equal to or less than the designated beneficiary's qualified higher education expenses, none of the earnings included in the distribution are included in income. However, if qualified tuition program distributions are greater than the designated beneficiary's qualified higher education expenses, or if the designated beneficiary has other tax favored or tax-free education benefits for the same year, some or all of the qualified tuition program earnings may be taxable. Publication 970, Tax Benefits for Education, provides information on adjustments that must be made to determine whether the exclusion is available.

  4. If a distribution is not used to pay qualified higher education expenses it is included in gross income. The income tax is increased by 10% of the amount of earnings which are so included. The 10% additional tax is imposed by IRC 529(c)(6) and IRC 530(d)(4) unless the distribution is

    1. made to a beneficiary (or to the estate of the designated beneficiary) on or after the death of the designated beneficiary,

    2. attributable to the designated beneficiary's being disabled (within the meaning of IRC 72(m)(7)),

    3. made on account of a scholarship, allowance, or payment described in IRC 25A(g)(2) received by the designated beneficiary to the extent the amount of the distribution does not exceed the amount of the scholarship, allowance, or payment,

    4. made on account of the attendance of the designated beneficiary at an academy listed in IRC 530(d)(4)(B)(iv) that does not exceed certain costs of advanced education attributable to such attendance,

    5. an amount includible in income solely because the qualified higher education expenses were taken into account in determining the Hope Credit or Lifetime Learning Credit, or

    6. made before 2004 and used to pay qualified higher education expenses, but included in income because it was paid from a qualified tuition program established and maintained by one or more eligible educational institutions.

  5. Contributions to a qualified tuition program are not deductible. These contributions (sometimes referred to as basis or investment in the account) are recovered ratably with earnings (if any). Participants in qualified tuition programs do not pay income tax on the basis that is returned with a distribution. If a final (total) distribution is made and not all the contributions have been recovered, the amount of unrecovered contributions may be a deductible loss. This loss is taken as an itemized deduction subject to the 2% adjusted gross income limit.

  6. A change in the designated beneficiary of an interest in a qualified tuition program is not considered a distribution subject to income tax if the new beneficiary is a member of the family of the former beneficiary.

  7. A distribution from a qualified tuition program that is, within 60 days of such distribution, transferred to the credit of another designated beneficiary who is a member of the family of the designated beneficiary with respect to whom the distribution was made, is not considered a distribution subject to income tax.

  8. A distribution from a qualified tuition program that is, within 60 days of such distribution, transferred to "another qualified tuition program for the benefit of the same designated beneficiary" is not considered a distribution subject to income tax as long as such transfer does not occur within 12 months from the date of a previous transfer to any qualified tuition program for the benefit of the designated beneficiary.

  9. Notice 2001-81, 2001-2 CB 617, provides guidance to qualified tuition programs concerning the computation of distributions. The notice also includes reporting, recordkeeping, and other guidance. The notice provides that this guidance will be incorporated in final regulations under IRC 529 and programs and participants may rely upon Notice 2001-81 until publication of final regulations.

7.25.44.5  (10-01-2005)
Reporting Requirements

  1. IRC 529(d) provides that each officer or employee having control of the qualified tuition program or their designee shall make such reports regarding the program to the Secretary and to designated beneficiaries with respect to contributions, distributions, and such other matters as the Secretary may require.

  2. The reports required by IRC 529 shall be filed at such time and in such manner and furnished to such individuals at such time and in such manner as may be required by the Secretary.

  3. IRC 6693(a) provides that a person required to file a report under IRC 529(d) relating to qualified tuition programs shall pay a penalty of $50 for each failure unless it is shown that such failure is due to reasonable cause.

  4. Prop. Treas. Reg. §1.529-1(a) provides that a qualified State tuition program is not required to file Form 990, Return of Organization Exempt From Income Tax, Form 1041, U.S. Income Tax Return for Estates and Trusts, or Form 1120, U.S. Corporation Income Tax Return. The preamble to the proposed regulations, at 63 FR 45,024 (1998), states that taxpayers may rely on the proposed regulations for taxable years ending after August 20, 1996.

  5. A qualified tuition program may be required to file Form 990-T, Exempt Organization Business Income Tax Return, if it has unrelated business taxable income.

  6. A qualified tuition program is required to file Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530), for distributions from the program. Form 1099-Q is not required for a change in the name of the designated beneficiary with respect to a qualified tuition program interest if the new beneficiary is a member of the family of the former beneficiary.

  7. The taxpayer who receives a Form 1099-Q is responsible for determining the taxability of any earnings reported as part of a distribution. The taxpayer is also responsible for determining whether any taxable earnings are also subject to the additional 10% tax. The additional 10% tax is reported on Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.

  8. Publication 970, Tax Benefits for Education, provides additional information on adjustments and allocations that may be considered with respect to distributions from qualified tuition programs in order to determine whether an exclusion is available.


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