What’s A Qualified Higher Education Expense?

What is considered a “qualified higher education expense,” or QHEE, for a 529 withdrawal has changed over the years. What was once a relatively restrictive definition has become more flexible due to the extensive work of advocates and legislators.

It is important to remember that money in a 529 account can always be withdrawn at any time for any reason. The question is whether that withdrawal is tax-free, penalty-free, or taxable. Non-qualified withdrawals are subject to income tax as well as a 10 percent penalty on the earnings portion of the withdrawal. Further, distributions taken from a 529 plan are allocated between principal and earnings on a pro-rata basis, which means every withdrawal includes an earnings portion. As a result, it is important that account owners have a thorough understanding of what does and does not qualify.

Qualified expenses

There are five main categories that constitute qualified expenses.

1. Tuition, fees, books, supplies, and equipment are all qualified expenses. They are grouped because these are all expenses that must be required by the school for enrollment or attendance at the institution. If a fee is not required by the school, such as drama club fees, it would be considered non-qualified.
2. Room and board, which includes the costs of rent (whether living on or off-campus), and food. To be considered qualified, these costs must be less than or equal to the room and board allowance from the college’s cost of attendance figures (provided by the school; example) or the actual amount charged by the school if living in on-campus housing. So, if the total cost living off-campus exceeds the school’s allowance, the student would have to pay the difference using funds from another source. The beneficiary must be enrolled at least half-time for room and board expenses to qualify regardless of whether they are on- or off-campus.
3. Computers, peripheral equipment, computer software, and internet access charges are all considered qualified expenses. This is a recent change from the 2015 PATH Act for the benefit of 529 account owners, whereas previously the school had to specifically require these items. Now account owners can reimburse themselves for a laptop and printer without a worry.
4. If the beneficiary has a disability, certain special needs services and equipment needed for enrollment or attendance may qualify. This includes transportation costs, which are generally not considered a qualified expense, as well as equipment such as a wheelchair or prosthetics.
5. As a result of the 2017 Tax Cuts and Jobs Act, up to $10,000 for tuition at public, private, or religious K–12 schools is now considered qualified. However, this is limited to tuition only, and you need to be cautious depending on your state. Not every state conforms to federal code for this expense. This means while your K-12 tuition withdrawal would be federal tax-free, the state may impose tax on earnings and – potentially – claw back any prior state tax benefits taken. As a result, you should contact your state and, potentially, a tax professional prior to making a withdrawal for K-12 tuition expenses.

Non-qualified expenses

The definition of a qualified expense is intentionally broad, but there are some common expenses that do not qualify. Be sure to know what these are, as claiming a non-qualified expense may result in a tax liability.

• Travel – Transportation costs to and from the school do not qualify; cars, airfare, gas, etc. are all excluded.
• Sports and activity fees – Fees for extracurricular activities cannot be reimbursed with funds from a 529 account. Even if the beneficiary has a sports scholarship and must play, sports fees would not be considered qualified.
• Student loans – You cannot pay back student loans using 529 savings (yet). However, there have been several bills proposed to allow this, such as the SECURE Act.
• Electronics – Projectors, home theater equipment, photocopiers and other electronics primarily used for entertainment are not qualified unless they are specifically required by the school for enrollment or attendance.
• Insurance – Health insurance and medical expenses, including student health fees.
• Expenses used to claim the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit – Expenses used to generate the AOTC or Lifetime Learning Credit must be excluded from qualified expenses. This is to prevent “double-dipping” of federal tax benefits.

Penalty-free withdrawals

There are some special situations where non-qualified withdrawals can be made without incurring the additional 10% penalty on earnings. However, the account owner would still be liable for income tax on earnings.

• Scholarships and grants
• Veteran’s assistance
• Death
• Disability
• Attendance at a U.S. military academy

Penalty-free withdrawals

There are some special situations where non-qualified withdrawals can be made without incurring the additional 10% penalty on earnings. However, the account owner would still be liable for income tax on earnings.

• Scholarships and grants
• Veteran’s assistance
• Death
• Disability
• Attendance at a U.S. military academy

Unusual Situations

Qualified expenses – even if paid for by the account owner – need to be incurred by the student in relation to enrollment or attendance at a university. For example, while the parent might pay the bill, it is the student that owes tuition. Withdrawals taken from a 529 plan must also be taken in the same calendar year the expense is incurred. To this end, expenses paid for by another party for those incurred by the beneficiary can still be withdrawn from the 529 plan.

For example, let’s say grandma buys groceries for your 529 beneficiary – their granddaughter – a full-time undergraduate at University X. You as the account owner could take a withdrawal in the respective amount of the groceries, presumably to pay back grandma. Just know that the withdrawal will generate a 1099 to you as the account owner since you made the withdrawal, and you will need to tie that withdrawal back to the respective expense. This is to prevent two account owners from claiming the same expense.

Expenses incurred while participating in a gap year program offered through an eligible post-secondary institution may be qualified if they are incurred in relation to enrollment or attendance. As a result, for-credit gap year programs are likely to qualify. Legal guidance in this area is relatively vague, so you may need to do some detective work with the sponsoring institution to determine if expenses would be considered qualified.

Finally, if the beneficiary incurs expenses related to a study abroad program sponsored by a qualified institution for credit, those expenses would be considered qualified. The expenses themselves would still need to be qualified, meaning it would cover room & board, but not travel costs.

Additional Reading (External Links)

LII / Legal Information Institute

Irs

Irs

This information does not constitute tax advice and is provided for informational purposes only. Please consult your tax advisor, financial advisor, local taxing authority, and/or plan provider or sponsor for more information.