Penalties on 529 Distributions?
If a person has no earnings in a 529 (they have less than they put in) and takes a distribution from the account and doesn’t use the funds for qualified education expenses, am I correct in my understanding they would not be subject to the 10% penalty? As I understand it, the 10% penalty only applies only to earnings and each distribution is considered to be part earnings and part contributions and only the earnings portion is includable in income with the contribution portion not inlcudable in income. If there are no earnings, then nothing is includable in income and therefore no 10% penalty. Is that correct?
…and would a trust being involved in the ownership of a 529 have any bearing on penalties?
Permalink Submitted by Alan Spross on Wed, 2012-10-24 19:21
You are correct. If no earnings, then no tax or penalty. Trust ownership would not affect that.
However, if the person received a state income tax deduction for the contribution, a non qualified distribution could result in state income tax and/or penalty. Check with the applicable state tax agency.