Are there tax implications to putting a 529 plan withdrawal in my child’s name who is a minor?

by Gregory Paulding, CPA | Oct 25, 2018

I’m thinking about cashing out some of my child’s 529 plan, but paying it back with the sale of my house. I know I’m going to be taxed at my rate (22 percent) plus a 10 percent fee on any interest I withdraw. Would I pay less tax by putting the withdrawal in my minor child’s name because she has never had any income?

There are many unknown variables to the question at hand. Some assumptions must be made for a general answer to be given. The presumption of “paying it back” is subject to gifting limitations and the amount that is distributed. Also, the “cashing out” is assumed to be a nonqualified distribution. You are correct in that nonqualified distributions are subject to ordinary tax rates and the 10 percent premature penalty. You may need to consider state taxation on top of that. There are many exceptions to the penalty; however, it appears that you are somewhat knowledgeable about 529 plans and that you are not eligible for penalty exception in your circumstances. 

Understand that 529 plans may have an impact on the FAFSA application and may impact financial aid, depending on your circumstances. The matter of distributing plan assets to your minor child may complicate things. At first glance, your child may be in a lower tax bracket; but under the new tax law, the “kiddie tax” may come into effect for children under age 19 and full-time students under age 24. Under the new tax law, the tax is no longer computed as it relates to the parents’ tax rates, but is instead computed as it relates to trusts and estates. If you are filing as married filing jointly and are in the 22 percent bracket, that suggests that you have at least $77,400 of taxable income. Trust and estate tax brackets did not change under the new tax law, and if the taxable income piece of the 529 plan distribution exceeds $2,550, then the tax assessed against your child’s income will be taxed at 24 percent (if the income exceeds $9,150, then the tax rate is 35 percent). Therefore, know how much of the distribution is subject to tax and run the numbers.  

As always, consult with your tax adviser to gain more clarity regarding these issues as they relate to your circumstances.

For more resources, check out PICPA’s Money & Life Tips, Ask a CPA, or CPA Locator.

Answered by: Gregory Paulding, CPA, is president of Paulding & Associates PC in Erie, Pa.

The responses are based on the limited information provided by the questioner and apply the laws and regulations at the time of posting. Other options could arise as rules and regulations may change over time, including but not limited to the passage of the Tax Cuts and Jobs Act of 2017. They are intended to provide general information, not specific accounting or tax advice; they are not intended or written to be used and cannot be used for the purpose of avoiding or evading taxes or penalties under the IRS code or regulations. Views expressed do not imply an opinion of the PICPA, its officers, directors, employees, or members.
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