An offer in compromise (OIC) is an agreement between a taxpayer and the Internal Revenue Service that settles a taxpayer's tax liabilities for less than the full amount owed. That's the good news. The bad news is that not everyone is eligible to use this option to settle tax debt. In fact, nearly 60 percent of taxpayer requested offers in compromise were rejected by the IRS. If you owe money to the IRS and are wondering if an IRS offer in compromise is the answer, here's what you need to know.
If you can't pay your full tax liability or doing so creates a financial hardship, an offer in compromise may be a legitimate option. However, it is not for everyone, and taxpayers should explore all other payment options before submitting an offer in compromise to the IRS. Taxpayers who can fully pay the liabilities through an installment agreement or other means, generally won't qualify for an OIC.
To qualify for an OIC, the taxpayer must have:
Whether your offer in compromise is accepted depends on a number of factors; however, typically, an offer in compromise is accepted when the amount offered represents the most the IRS can expect to collect within a reasonable period of time. This is referred to as the reasonable collection potential (RCP). In most cases, the IRS won't accept an OIC unless the amount offered by a taxpayer is equal to or greater than the reasonable collection potential (RCP), which is how the IRS measures the taxpayer's ability to pay.
The RCP is defined as the value that can be realized from the taxpayer's assets, such as real property, automobiles, bank accounts, and other property. In addition to property, the RCP also includes anticipated future income minus certain amounts allowed for basic living expenses.
The IRS may accept an OIC based on one of the following criteria:
Doubt as to liability. An OIC meets this criterion only when there's a genuine dispute as to the existence or amount of the correct tax debt under the law.Doubt as to collectibility. This refers to whether there is doubt that the amount owed is fully collectible such as when the taxpayer's assets and income are less than the full amount of the tax liability.
Effective tax administration. This applies to cases where there is no doubt that the tax is legally owed and that the full amount owed can be collected but requiring payment in full would either create an economic hardship or would be unfair and inequitable because of exceptional circumstances.
When requesting an OIC from the IRS, use Form 656, Offer in Compromise, and also submit Form 433-A (OIC), Collection Information Statement for Wage Earners and Self-Employed Individuals. If you are applying as a business, use Form 433-B (OIC), Collection Information Statement for Businesses. A taxpayer submitting an OIC based on doubt as to liability must file additional forms as well.
A nonrefundable application fee, as well as an initial payment (also nonrefundable), is due when submitting an OIC. If the OIC is based on doubt as to liability, no application fee is required, however.
If the taxpayer is an individual (not a corporation, partnership, or other entity) who meets Low-Income Certification guidelines they do not have to submit an application fee or initial payment and will not need to make monthly installments during the evaluation of an offer in compromise.
The initial payment is based on which payment option you choose for your offer in compromise:
If the IRS rejects your OIC, you will be notified by mail. The letter will explain why the IRS rejected the offer and will provide detailed instructions on how to appeal the decision. An appeal must be made within 30 days from the date of the letter.
If you have any questions about the IRS Offer in Compromise program, don't hesitate to contact the office for more information.
Keeping full and accurate homeowner records is not only vital for claiming deductions on your tax return, but also for determining the basis or adjusted basis of your home. These records include your purchase contract and settlement papers if you bought the property, or other objective evidence if you acquired it by gift, inheritance, or similar means. You should also keep any receipts, canceled checks, and similar evidence for improvements or other additions to the basis.
Here are a few examples:
In addition, you should keep track of any decreases to the basis such as:
How you keep records is up to you, but they must be clear and accurate and must be available to the IRS. You must also keep these records for as long as they are important for the federal tax law.
Keep records that support an item of income or a deduction appearing on a return until the period of limitations for the return runs out. A period of limitations is the limited period of time after which no legal action can be brought.
For assessment of tax, the period of limitations is generally three years from the date you filed the return. When filing a claim for credit or refund, the period of limitations is generally three years from the date you filed the original return or two years from the date you paid the tax, whichever is later. Returns filed before the due date are treated as filed on the due date.
You may need to keep records relating to the basis of property longer than the period of limitations. For example, basis is needed to determine gain on home sale. Any gain on sale of a home is tax-exempt for amounts up to $250,000 ($500,000 for married couples). Basis is also important in figuring casualty loss, on conversion of the home to business use, or where there's a gift of the home (in this case, it is important to the donee). You should keep these records for as long as needed because they are important in figuring the basis of the property. Generally, this means for as long as you own the property and, after you dispose of it, for the period of limitations that applies to you.
If you have any questions as to what items are to be considered in determining basis, don't hesitate to call.
Did you know that the average tax refund was $2,729 for tax year 2018? While some taxpayers may find it advantageous to get a large tax refund, others may wish to have more of their money show up in their paychecks throughout the year. No matter which preference taxpayers choose, they should remember that they can make adjustments throughout the year that will influence the size of their refund when they file their tax return next spring.
The Tax Cuts and Jobs Act of 2017 made significant changes that affected almost every taxpayer. Most of these changes took effect in 2018 and you may have noticed it when you filed your on tax return earlier this year.
Many taxpayers ended up receiving refunds on their 2018 tax return that were smaller or larger than expected. Others found they owed additional tax when they filed. To avoid tax surprises like this, taxpayers may need to increase or reduce the amount of tax they have taken out of their pay and should check their paycheck withholding as soon as possible -- even if they did one last year.
Simple returns. For taxpayers whose tax situation is less complex, the easiest way to check whether their withholding is correct is to use the IRS Withholding Calculator on IRS.gov, which is designed to help employees make changes based on their individual financial situation.
Complex returns. Taxpayers with more complex tax situations such as married couples who both work, higher-income earners, and those who take certain tax credits or itemize might need to revise their Form W-4, Employee's Withholding Allowance Certificate, completely to ensure they have the right amount of withholding taken out of their pay. If you've been putting this off, it's not too late to adjust your tax withholding. Please call the office and speak with a tax and accounting professional who will evaluate your particular tax situation and help you determine how much tax you should withhold from your paycheck.
Small business owners or sole proprietors. Taxpayers who owe self-employment tax, individual taxpayers who need to pay the alternative minimum tax, those who owe tax on unearned income from dependents, and anyone with capital gains and dividends should contact the office and speak to a tax and accounting professional as well.
Life changes. Taxpayers should also check their withholding when there are life changes such as marriage or divorce, birth or adoption of a child, retirement, new job or loss of a job, purchase of home, or have filed for Chapter 11 bankruptcy.
Certain life changes might affect a taxpayer's itemized deductions or tax credits. As such, taxpayers should check their withholding if they experience changes to the following:
Income not subject to withholding. Some taxable income is not subject to withholding. Taxpayers with taxable income not subject to withholding and who also have income from a job may want to adjust the amount of tax their employer withholds from their paycheck. Income that is generally not subject to withholding includes interest and dividends, capital gains, self-employment and gig economy income, and IRA distributions, including certain Roth IRAs.
If you have any questions about tax withholding, don't hesitate to call and speak to an accounting professional who can help.
Of all the retirement plans available to small business owners, the SIMPLE IRA plan (Savings Incentive Match PLan for Employees) is the easiest to set up and the least expensive to manage. The catch is that you'll need to set it up by October 1st. Here's what you need to know.
SIMPLE IRA Plans are intended to encourage small business employers to offer retirement coverage to their employees. Self-employed business owners are able to contribute both as employee and employer, with both contributions made from self-employment earnings. In addition, if living expenses are covered by your day job (or your spouse's job), you would be free to put all of your sideline earnings, up to the ceiling, into SIMPLE IRA plan retirement investments.
A SIMPLE IRA plan is easier to set up and operate than most other plans in that contributions go into an IRA you set up. Requirements for reporting to the IRS and other agencies are minimal as well. Your plan's custodian, typically an investment institution, has the reporting duties and the process for figuring the deductible contribution is a bit easier than with other plans.
SIMPLE IRA plans calculate contributions in two steps:
1. Employee out-of-salary contribution
The limit on this "elective deferral" is $13,000 in 2019, after which it can rise further with the cost of living. Owner-employees age 50 or older can make an additional $3,000 deductible "catch-up" contribution (for a total of $16,000) as an employee in 2019.2. Employer "matching" contribution
The employer match equals a maximum of three percent of employee's earnings.
An owner-employee age 50 or over in 2019 with self-employment earnings of $40,000 could contribute and deduct $13,000 as employee plus an additional $3,000 employee catch up contribution, plus a $1,200 (three percent of $40,000) employer match, for a total of $17,200.
Because investments are through an IRA you must work through a financial institution acting, which acts as the trustee or custodian. As such, you are not in direct control and will generally have fewer investment options than if you were your own trustee, as is the case with a 401(k).
You also cannot set up the SIMPLE IRA plan after the calendar year ends and still be able to take advantage of the tax benefits on that year's tax return, as is allowed with Simplified Employee Pension Plans, or SEPs. Generally, to make a SIMPLE IRA plan effective for a year, it must be set up by October 1 of that year. A later date is allowed only when the business is started after October 1 and the SIMPLE IRA plan must be set up as soon as it is administratively feasible.
Furthermore, once self-employment earnings become significant however, other retirement plans may be more advantageous than a SIMPLE IRA retirement plan.
If you are under 50 with $50,000 of self-employment earnings in 2019, you could contribute $13,000 as employee to your SIMPLE IRA plan plus an additional three percent of $50,000 as an employer contribution, for a total of $14,500. In contrast, a Solo 401(k) plan would allow a $31,500 contribution.With $100,000 of earnings, the total for a SIMPLE IRA Plan would be $16,000 and $44,000 for a 401(k).
If the SIMPLE IRA plan is set up for a sideline business and you're already vested in a 401(k) in another business or as an employee the total amount you can put into the SIMPLE IRA plan and the 401(k) combined (in 2019) can't be more than $19,000 or $25,000 if catch-up contributions are made to the 401(k) by someone age 50 or over. So, someone under age 50 who puts $9,500 in her 401(k) can't put more than $9,500 in her SIMPLE IRA plan for 2019. The same limit applies if you have a SIMPLE IRA plan while also contributing as an employee to a 403(b) annuity (typically for government employees and teachers in public and private schools).
You can set up a SIMPLE IRA plan account on your own; however, most people turn to financial institutions. SIMPLE IRA Plans are offered by the same financial institutions that offer any other IRAs and 401(k) plans.
You can expect the institution to give you a plan document and an adoption agreement. In the adoption agreement, you will choose an "effective date," which is the start date for payments out of salary or business earnings. Again, that date can't be later than October 1 of the year you adopt the plan, except for a business formed after October 1.
Another key document is the Salary Reduction Agreement, which briefly describes how money goes into your SIMPLE IRA plan. You need such an agreement even if you pay yourself business profits rather than salary. Printed guidance on operating the SIMPLE IRA plan may also be provided. You will also be establishing a SIMPLE IRA plan account for yourself as participant.
SIMPLE IRA Plans are an excellent choice for home-based businesses and ideal for full-time employees or homemakers who make a modest income from a sideline business and work well for small business owners who don't want to spend a lot of time and pay high administration fees associated with more complex retirement plans.
If you are a business owner interested in discussing retirement plan options for your small business, don't hesitate to contact the office today.
Taxpayers should be aware that a new IRS impersonation scam email campaign is making the rounds. This latest scheme is yet another reminder that tax scams are a year-round business for thieves and taxpayers should be on guard at all times.
This latest scam uses dozens of compromised websites and web addresses that pose as IRS.gov. By infecting computers with malware, these scammers may be able to gain control of the taxpayer's computer or secretly download software that tracks every keystroke, eventually giving them passwords to sensitive accounts such as financial accounts.
The email subject line may vary, but recent examples use the phrase "Automatic Income Tax Reminder" or "Electronic Tax Return Reminder." The body of the email contains links that show an IRS.gov-like website with details pretending to be about the taxpayer's refund, electronic return or tax account.
In addition, the emails contain a "temporary password" or "one-time password" to "access" the files to submit the refund. But when taxpayers try to access these, it turns out to be a malicious file.
While much progress has been made by the IRS in the fight against stolen identity refund fraud, the battle against phishing emails and harassing phone calls remains ongoing and affects taxpayers of all incomes.
Remember: the IRS does not send unsolicited emails and never emails taxpayers about the status of refunds. Nor does it initiate contact with taxpayers by email, text messages or social media channels to request personal or financial information. This includes requests for PIN numbers, passwords or similar access information for credit cards, banks or other financial accounts.
The IRS also doesn't call to demand immediate payment using a specific payment method such as a prepaid debit card, gift card or wire transfer. Generally, the IRS will first mail a bill to any taxpayer who owes taxes.
Questions? Help is just a phone call away.
More than 400,000 eligible taxpayers whose withholding and estimated tax payments fell short of their total 2018 tax liability will have the estimated tax penalty automatically waived or refunded (if they already paid the penalty) on 2018 returns filed with the IRS.
Eligible taxpayers who have already filed a 2018 return do not need to request penalty relief, contact the IRS or take any other action to receive this relief.
The automatic waiver applies to any individual taxpayer who paid at least 80 percent of their total tax liability through federal income tax withholding or quarterly estimated tax payments but did not claim the special waiver available to them when they filed their 2018 return earlier this year. While some taxpayers were unaware of the waiver, others filed their returns too early to take advantage of it.
Earlier this year, the IRS lowered the usual 90 percent penalty threshold to 80 percent to assist taxpayers whose withholding and estimated tax payments fell short of their total 2018 tax liability. The IRS also removed the requirement that estimated tax payments be made in four equal installments, as long as all of the estimated tax payments were made by January 15, 2019. In addition, the 90 percent threshold was initially lowered to 85 percent on January 16 and then lowered further to 80 percent on March 22.
Over the next few months, affected taxpayers will receive copies of CP 21 notices in the mail granting them penalty relief. Furthermore, any eligible taxpayer who already paid the penalty will receive a refund check about three weeks after their CP21 notice regardless if they requested penalty relief.
If you haven't filed a 2018 return yet, you should claim the waiver on your return when you do file. The fastest and easiest way is to file your return electronically. You may also file a paper return and claim the waiver by filling out Form 2210, Underpayment of Estimated Tax by Individuals, Estates and Trusts, and attaching it to your 2018 return.
If you have any questions about the estimated tax penalty waiver or estimated taxes, don't hesitate to contact the office.
If you're thinking about starting a nonprofit and want to apply for tax-exempt status under Section 501(c)(3) of the tax code, you'll need to use Form 1023, Application for Recognition of Exemption Under Section 501(c)(3) of the Internal Revenue Code. Here are five tips to ensure a successful application:
1. The application must be complete and must include the user fee.
2. Some organizations may be able to file Form 1023-EZ, a streamlined version, if they meet certain criteria such as projected or past annual gross receipts of $50,000 or less for a period of three years.
3. Churches and their integrated auxiliaries (organizations affiliated with a church or association of churches that receives financial support primarily from internal church sources and not public or governmental sources), as well as public charities whose annual gross receipts are normally less than $5,000 do not need to apply for 501(c)(3) status to be tax-exempt.
4. Every tax-exempt organization, including a church, should have an Employer Identification Number (EIN) regardless of whether the organization has employees. An employer identification number is an organization's account number with the IRS and is required for the organization to apply for tax-exempt status. Once the EIN is received by the organization, it must include it on the application.
5. Generally, an organization that is required to apply for recognition of exemption must notify the IRS within 27 months from the date it was formed.
If you have any questions about applying for tax-exempt status, please call for assistance.
If you're a small business owner who uses your home for business you may be eligible to claim the home office deduction, which allows you to deduct certain home expenses on your tax return. The benefit to this, of course, is that it can reduce the amount of your taxable income.
Here are seven tips to help you understand the home office deduction and determining whether you can claim the home office deduction on your tax return:
1. The home office deduction is available to both homeowners and renters.
2. There are certain expenses taxpayers can deduct including mortgage interest, insurance, utilities, repairs, maintenance, depreciation, and rent.
3. Taxpayers must meet specific requirements to claim home expenses as a deduction; however, the deductible amount of these types of expenses may be limited.
4. The term "home" for purposes of this deduction is defined as a house, apartment, condominium, mobile home, boat or similar property. It also includes structures on the property such as an unattached garage, studio, barn or greenhouse. It does not include any part of the taxpayer's property used exclusively as a hotel, motel, inn or similar business.
5. To qualify for the home office deduction your home must meet two basic requirements:
6. Expenses that relate to a separate structure not attached to the home qualify for a home office deduction only if the structure is used exclusively and regularly for business.
7. Taxpayers who qualify may choose one of two methods to calculate their home office expense deduction:
Regular method. Deductions for a home office are based on the percentage of the home devoted to business use. Taxpayers who use a whole room or part of a room for conducting their business need to figure out the percentage of the home used for business activities to deduct indirect expenses. Direct expenses are deducted in full.
Please call if you have questions about the home office deduction.
If you've given money or property to someone as a gift, you may owe federal gift tax. Many gifts are not subject to the gift tax, but there are exceptions. Because gift tax laws can be confusing, here are seven tips you can use to figure out whether your gift is taxable.
1. Most gifts are not subject to the gift tax. For example, there is usually no tax if you make a gift to your spouse or to a charity. If you make a gift to someone else, the gift tax usually does not apply until the value of the gifts you give that person exceeds the annual exclusion for the year. In 2019, the annual exclusion amount is $15,000.
2. Gift tax returns do not need to be filed unless you give someone, other than your spouse, money or property worth more than the annual exclusion for that year.
3. Generally, the person who receives your gift will not have to pay any federal gift tax because of it. Also, that person will not have to pay income tax on the value of the gift received.
4. Making a gift does not ordinarily affect your federal income tax. You cannot deduct the value of gifts you make (other than deductible charitable contributions).
5. The general rule is that any gift is a taxable gift. However, there are many exceptions to this rule. For example, the following gifts are not taxable:
6. You and your spouse can make a gift of up to $30,000 to a third party without making a taxable gift. The gift can be considered as made one-half by you and one-half by your spouse. If you split a gift you made, you must file a gift tax return to show that you and your spouse agree to use gift splitting.
7. You do not have to file a gift tax return to report gifts to political organizations and gifts made by paying someone's tuition or medical expenses.
If you have any questions about the gift tax, please contact the office for assistance.
Bill-paying may be your least favorite accounting activity. You definitely know how those checks and online payments affect your account balances, but it's more than that. Staying up to date with your bills and paying them on time (but not too early) takes a supreme organizational effort.
If you're using a manual bookkeeping system, you know how difficult it is to keep up. QuickBooks offers several options for helping you with this. You can set reminders and/or put the due dates on your calendar. If you're using QuickBooks 2016 or later, you have access to another tool: Bill Tracker.
QuickBooks Bill Tracker is similar to the software's Income Tracker. If you've used that, you know that it provides a way to get a birds-eye view of your accounts receivable. You can see where every transaction falls in your income "pipeline" (estimates, open invoices, etc.).
Bill Tracker works similarly, but for accounts payable. It has two advantages over just opening your Vendor Center and clicking the Transactions tab. First, it displays the Status of each transaction. Second, it contains Action links, so you can do more than simply open each entry.
You can see in the image above that the Open Bills list has three alternate views that you can open by clicking on them in the drop-down list: Item Receipt, Credit, and Unapplied Payments. If you have questions on any of these, please call and QuickBooks professional can explain them to you, since you should know when to consult these lists.
Bill Tracker defaults to the broadest view possible. That is, when you select a category of transactions, it shows all of the active ones. But a series of drop-down lists below the main toolbar gives you control over what subset of information is displayed there. You can narrow your list down to one vendor, for example, and choose a date range.
Data columns are different for each list. When you're displaying Overdue transactions, the labels read Vendor, Type, Number, Date, Due Date, Aging, Status, Amount, Open Balance, and Action. You get a thorough description of each entry at a glance.
As was mentioned earlier, Bill Tracker lets you work with transactions as well as just view them. Click on Purchase Orders and open the drop-down list at the end of one of the rows in the Action column. You can see in the image below what your options are there, including Convert to Bill. When the Open Bills list is active, you'll be able to click on Pay Bill.
To see what else you can do with individual transactions or groups of them, look in the lower left corner of the screen and locate the Batch Actions and Manage Transactions buttons. With the Purchase Orders list open, click in the box in front of one or more to create a check mark. Open the Batch Actions menu. You'll see that only two options are available to you here; the others are grayed out. You can Print Selected Purchase Orders or Close Purchase Orders. Pay Bills is only active when you're in a list that allows that.
Now, open the Manage Transactions list. You can create transactions from this menu by clicking on Purchase Order, Bill, CC Charge, or Check. If you select Edit Highlighted Row, the original transaction will open.
Remember that you should never write a check to pay a bill if you're using QuickBooks' bill-payment tools. If you've already entered the bill, click Pay Bills on the home page or open the Vendors menu and select Pay Bills. Please call if you have questions about this process.
QuickBooks offers multiple ways to take the same actions in accounts payable; Bill Tracker is just one. But this instant overview can tell you quickly where you stand with your vendors -- and help you avoid late payments. As always, help is just a phone call away.
Employees Who Work for Tips - If you received $20 or more in tips during August, report them to your employer. You can use Form 4070.
Individuals - Make a payment of your 2019 estimated tax if you are not paying your income tax for the year through withholding (or will not pay in enough tax that way). Use Form 1040-ES. This is the third installment date for estimated tax in 2019.
Partnerships - File a 2018 calendar year income tax return (Form 1065). This due date applies only if you were given an additional 6-month extension. Provide each shareholder with a copy of Schedule K-1 (Form 1065) or a substitute Schedule K-1.
S corporations - File a 2018 calendar year income tax return (Form 1120S) and pay any tax due. This due date applies only if you made a timely request for an automatic 6-month extension. Provide each shareholder with a copy of Schedule K-1 (Form 1120S) or a substitute Schedule K-1.
Corporations - Deposit the third installment of estimated income tax for 2019. A worksheet, Form 1120-W, is available to help you make an estimate of your tax for the year.
Employers - Nonpayroll withholding. If the monthly deposit rule applies, deposit the tax for payments in August.
Employers - Social Security, Medicare, and withheld income tax. If the monthly deposit rule applies, deposit the tax for payments in August.
A 529 plan is a savings plan that is used to save money for college which offers certain tax and financial aid benefits. 529 plans are quite versatile and they can be used for other things too, such as K-12 tuition bills.
There are a couple of different types of 529 plans. The first type is a college savings plan and the second is a prepaid tuition plan. Most states have some sort of 529 plan available to their residents. You can also use a 529 plan provided via a conglomerate of universities and colleges.
If you like, you can invest in another state's 529 plan other than your own. These plans can be used to pay for college tuition expenses at any qualified college across the country. Generally speaking, the college you select will not be affected by which state you had your 529 plan with.
If you live in Vermont for example, you could theoretically invest in a 529 plan from California or vice versa. If you lived in Vermont and used the California plan, as in the example described above, you could go to school in Florida, and that would be perfectly acceptable with the plan.
There are over 6000 U.S. colleges and universities and over 400 foreign educational institutions which work with 529 plans.
The vast majority of states have some form of 529 plan available to their residents. Each state chooses whether or not to provide one or more 529 plans. Be sure to check out the benefits and features of your state's 529 plan and compare them to other states you could invest in instead to see which 529 plan you would prefer to invest with.
Provided that your selected plan meets the requirements of the law, federal tax code provides certain tax benefits. One of those benefits is 5-year gift tax averaging and free qualified distributions.
Certain states provide tax incentives to investors in their state 529 plans as well. Each state will determine whether to provide one or more 529 plans to their citizens and what features and benefits it will provide.
529 plans fall into two general categories:
Prepaid Tuition Plans allow you to pay some or all of the costs of a same-state public college education ahead of time. These plans can also be adapted for use at out of state or private colleges. The Private College 529 Plan is a different plan for private colleges that is sponsored by 250 different private educational institutions.
College Savings Plans work a lot like a Roth IRA or Roth 401(k). They invest your after-tax contributions in investment products like mutual funds or other investments. 529 plans have different methods of investing their funds, so you can choose a plan that fits your investment style. You can also keep track of the performance of the 529 plan you choose, and look at its historical performance over time to see how it compares to other similar plans that are available to you.
Specific educational institutions can provide a pre-paid tuition plan but not a college savings plan.
529 plans are investment accounts that provide tax-free earnings growth and also tax-free withdrawals if the funds are used for qualified education expenses. You can use your 529 plan funds to pay for all applicable tuition and supply related expenses such as books, equipment, supplies, computers, and even things like room and board. You can also make withdrawals of up to $10,000 per year, tax-free, per person to pay for tuition at public, private, and religious K-12 schools.
Technically, all of the money you put into a 529 plan is actually your money, so you can take it out at any time and for any purpose. However, if you do so, you'll need to pay taxes and a 10% penalty on any non-qualified withdrawals. There are certain exceptions to this rule.
At the college or post-secondary levels, any expenses that are required to enroll in one of these eligible institutions will be covered. However, that doesn't necessarily mean that every single cost that you think is necessary will be covered according to the IRS. Things like health insurance, transportation costs, and student loan payments, for example, are not qualified.
Similar to with a Roth IRA, the contributions you make to a 529 plan are after tax and not deductible on your federal income taxes. However, about 30 different states do offer various state income tax deductions or credits for those who participate in 529 plans in their state.
When you are ready to use a 529 plan, you can generally distribute the funds to either the plan holder, the student, or the school. In certain cases your plan may also allow you to make payments to third parties such as a landlord for room and board. Be sure to check with your specific 529 plan to see what your distribution options are. You may also need to report any contributions or withdrawals to your 529 plan to the IRS on your annual tax returns.
You never know what's going to happen, and it's common for people to worry about losing the money invested in a 529 plan if your child doesn't decide to go to college or if they get a scholarship. Usually, you will need to pay income tax and a penalty percentage on the money you withdraw from a 529 plan for purposes other than education or other qualified expenses.
However, you can usually get this penalty wave if any of the following situations are true:
Your plan beneficiary gets a tax free scholarship
They die or become disabled
The student attends a US military Academy
Any earnings you make on the plan will generally be subject to federal and sometimes state income taxes.
There are a few options available if you need to take out the money for a purpose other than that which was originally intended:
You could leave the funds in the account in case the student decides to go to college later
You could change yourself to be the beneficiary on the account and go to college yourself
You can roll the funds into a 529 ABLE account for people with disabilities
You could also take up to $10,000 out for K-12 tuition
While 529 plans and tax law are complex, it can be well worth learning about the benefits. Let your tax professional know what your goals are so you get the most out of your investment.
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