part7-82

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 beneficiarys 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
    beneficiarys 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 beneficiarys 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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