ExpertMedium1 markMultiple Choice
CPA · Question 67 · Area I: Individual Compliance and Planning
A taxpayer contributes $5,000 to a 529 Plan in Year 1. The state offers a tax deduction. In Year 3, the account is worth $7,000. The taxpayer withdraws $7,000 for non-qualified expenses. What is the federal tax consequence?
A taxpayer contributes $5,000 to a 529 Plan in Year 1. The state offers a tax deduction. In Year 3, the account is worth $7,000. The taxpayer withdraws $7,000 for non-qualified expenses. What is the federal tax consequence?
Answer options:
A.
$7,000 is taxable income.
B.
$2,000 is taxable income + 10% penalty.
C.
$0
D.
$2,000 is taxable income; no penalty.
How to approach this question
529 Rule: Principal comes back tax-free. Earnings are Tax-Free IF qualified. If Non-Qualified -> Earnings are Taxed + 10% Penalty.
Full Answer
B.$2,000 is taxable income + 10% penalty.✓ Correct
IRC §529. The earnings portion of a non-qualified distribution is included in gross income and subject to a 10% penalty. The return of principal is tax-free.
Common mistakes
Taxing the entire distribution.
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