How do I properly report a 529 distribution on tax return when not used for education?

Thanks for the explanation. When you say the earnings should be reported as "Other Income" on Schedule 1, do you list it as "529 plan non-qualified distribution" or something else specific? Also, does this count as unearned income that could affect their social security taxation?

On Schedule 1, you can describe it as "529 plan earnings - non-qualified distribution" in the description field next to line 8z (Other Income). This helps identify the source clearly if there are any questions. Yes, this would be considered unearned income and could potentially impact how their Social Security benefits are taxed if they're receiving them. The additional income could push more of their Social Security benefits into the taxable range depending on their overall income level. It's something to be aware of when calculating their total tax situation.

Wait, there's a scholarship exception to the penalty? How does that work? My daughter got a partial scholarship but we still withdrew the full 529 balance.

I'm skeptical about these tax services. How does it handle situations where the original account owner is different from the beneficiary? In my case the grandparents opened the account but we control the distributions. Does this tool know all those nuances?

The scholarship exception allows you to withdraw up to the amount of tax-free scholarships your student received without paying the 10% penalty, though you'll still owe income tax on the earnings portion. You'll need documentation of the scholarship amount to qualify for this exception. The tool definitely handles complex ownership situations. It specifically asks who owns the account, who the beneficiary is, and who received the distribution - then gives the appropriate tax guidance for each party. In your case, it would explain the reporting requirements for both the grandparents and your family since different parties have different tax implications in the 529 ecosystem.

How exactly does this service work? Do they just call the IRS for you or what? I don't understand how they get you through faster than if you just called yourself.

This sounds too good to be true. The IRS wait times are legendary. I find it hard to believe any service could actually get you through that quickly when the IRS itself is so overwhelmed.

The service actually uses a proprietary system that navigates the IRS phone tree and waits on hold for you. When they reach a live agent, they call you and connect you directly - so you don't waste your time listening to hold music. It's not that they have a special line to the IRS, they just handle the waiting part so you don't have to. I was skeptical too until I tried it. The IRS is definitely still overwhelmed, but that's exactly why this service is valuable. They wait in the queue for hours if necessary, but you only get called when an actual agent is on the line. In my experience, the 20 minutes was how long it took from when I submitted my request until I was talking to an agent - the service might have been on hold much longer than that on my behalf.

Is there any resource that lists the different state rules? I'm in New York and wondering if I'll face the same issue with state recapture.

There's no single comprehensive resource I've found, but your best bet is to check your specific state's tax department website. For New York specifically, they do have recapture provisions if you claimed deductions for contributions in previous years and then take non-qualified distributions. You'll need to add back those previous deductions as income on your NY state return. The recapture rules vary significantly by state - some like California never offered deductions so there's nothing to recapture, while others like Illinois (where I am) are quite strict. Your state's 529 plan website often has more user-friendly explanations than the tax department sites.

In TurboTax, you need to go to the "Federal" section, then "Income & Expenses," then "Less Common Income," and look for the option about "Other Reportable Income." From there, you should see options for education distributions including 529 plans. Make sure you also complete the Form 5329 section for the penalty (unless an exception applies). It's not super intuitive, but it's in there!

This is really helpful advice about the timing and beneficiary change options! I'm curious though - if they change the beneficiary to another family member after taking a distribution, does that affect the tax treatment of the withdrawal they already took? Or would that only apply to future distributions from any remaining balance? Also, regarding the documentation for the scholarship exception, does it matter if the scholarship was for tuition only versus room and board? I know qualified education expenses include both, but I'm wondering if the type of scholarship affects how much you can withdraw penalty-free.

Great question about the timing! Changing the beneficiary after taking a distribution won't change the tax treatment of that withdrawal - once it's taken and reported as non-qualified, that's locked in. The beneficiary change would only affect future distributions from any remaining balance in the account. Regarding scholarship types, the penalty exception applies to the total amount of tax-free scholarships received, regardless of whether they're designated for tuition, room and board, or other qualified expenses. What matters is the scholarship amount that's excludable from the student's income under IRC Section 117. So if your daughter received a $10,000 scholarship (whether for tuition only or mixed expenses), you could withdraw up to $10,000 from the 529 without the 10% penalty - though you'd still owe income tax on the earnings portion of that withdrawal. @c86e83e24618 Just make sure you keep good documentation of the scholarship award letters showing the amounts and that they qualify as tax-free educational assistance.

This is really helpful clarification about the ownership vs beneficiary distinction! I'm new to 529 plans and wasn't sure how the tax responsibility flows when there are multiple parties involved. Just to make sure I understand correctly - even though the daughter was the beneficiary, since the grandparents were the account owners and received the distribution, all the tax consequences (both the income reporting and any penalties) fall on them, not the daughter or her parents? Also, regarding the gift tax exclusion limits you mentioned - does it matter that the money originally came from a 529 plan, or is it treated just like any other cash gift once it hits their bank account? I want to make sure there aren't any special rules I'm missing for gifts that originated from education accounts.