A 529 plan is maintained by the state to help residents save for college. You aren’t eligible to deduct contributions made to a 529 plan, but your contributions will increase tax-free for as long as it remains saved in the plan. Even if you use the money for qualified educational expenses, earnings continue to be tax-free. When you’re ready for distributions, reporting the amounts are important when you file your tax return.

Forms for 529 Plan

Taking distributions from your 529 plan will generate a Form 1099-Q from your financial institution that handles your plan. This form documents how much you received from your plan, along with how much of that amount was generated from earnings. All distributions are prorated between contributions and earnings, in that the percentage of contributions you added to your plan determines the portion of your distribution that is from those contributions. That means that a 529 plan with $4,500 in contributions that generates $500 worth of earnings will result in 90% of your distributions coming from contributions, and 10 percent as earnings.

Qualified Distributions

You aren’t required to report distributions from a 529 plan as long as it is considered a qualified distribution. Fully qualified distributions are used entirely for expenses such as tuition, fees, books, supplies, and room and board for students enrolled at least half-time. Qualified distributions don’t have to be reported on any tax forms, and you aren’t required to file a form to prove your qualified expenses.

Non-Qualified Distributions

At tax time, you are required to report any distributions that aren’t used to pay for qualified expenses. These distributions are treated as taxable income. If your 529 Plan has 90% contributions and 10% earnings as stated above, and you receive a non-qualified distribution of $1,000 you’ll be taxed on 10% of that $1,000- $100- as it is considered income. If half of the distribution is used towards qualified expenses, then the portion considered earnings is halved as well, meaning only $50 is taxed. On your Form 1040, report the income on line 21.

Withdrawal Penalties

There is a ten percent early withdrawal penalty assessed to taxable earnings on non-qualified distributions. There are a few exceptions to this penalty, including students who attend U.S. military academy, becomes permanently disabled, or receives a scholarship that covers expenses that would be considered qualified under the 529 plan. You can calculate the penalty using Part II of the Form 5329, even if you are trying to claim an exception. You’ll report penalty amount on your Form 1040, line 58.