689 / Are certain distributions from a qualified tuition program (529 Plan) taxable?

In the case of excess cash distributions, the amount otherwise includable in gross income must be reduced by a proportion that is equal to the ratio of expenses to distributions.² In-kind distributions are not includable in gross income so long as they provide a benefit to the distributee which, if paid for by the distributee, would constitute payment of a qualified higher education expense.³

Nonqualified distributions (i.e., distributions that are not used to pay “qualified higher education expenses”) are includable in gross income. However, the amount of the distribution representing the amount paid or contributed to the 529 plan are not taxable. An individual receiving a distribution from a 529 plan will receive a Form 1099-Q. The gross distribution received is entered in Box 1 of the form. That amount will be divided between the earnings generated from the 529 plan (Box 2) and the basis (return of investment) (Box 3). Consider the following example based on the example in IRS Publication 970:

Example: In 2013, Asher’s parents opened a 529 plan. Over a number of years, they contributed $18,000 to the plan. Ten years later, the balance in the plan was $27,000. At that time, Asher enrolled in college and paid $8,300 of qualified education expenses for the rest of the year. Those expenses were paid from the following sources: