IRS Notices Rise For 529 Plans, Education Tax Credits

IRS notices related to 529 plans and education tax credits are increasing as more families rely on education savings to cover rising tuition costs. Tax professionals say errors on tax returns involving qualified tuition programs, student aid, and overlapping benefits are drawing closer scrutiny from the Internal Revenue Service.

Expanded Section 529 Rules Draw IRS Attention

Recent legislative changes have expanded the uses of a Section 529 plan, particularly for K-12 tuition and other elementary and secondary education expenses. For distributions made after December 31, 2025 (beginning with tax year 2026), families may withdraw up to $20,000 annually from 529 college savings plans to pay K-12 tuition and other qualifying elementary and secondary education expenses. For tax year 2025 returns, the prior federal limit of $10,000 per year per beneficiary continues to apply. Families filing 2025 returns should use the $10,000 figure; the higher $20,000 limit does not apply to distributions taken in 2025.

Despite the expanded access, IRS guidance under Code Sec. 529 continues to require that withdrawals be limited to qualified education expenses. Financial institutions report distributions from a 529 account on Form 1099-Q, which the IRS compares against tuition expenses and other costs reported on a tax return.

Tax professionals say confusion often arises when families assume all educational funds qualify. While tuition paid to an eligible educational institution generally qualifies, withdrawals exceeding qualified distributions may result in taxable income and penalties under the Internal Revenue Code.

Double Use Of Education Benefits Triggers Notices

One of the most common IRS enforcement issues involves using the same tuition expenses for multiple tax benefits. Tuition paid using a 529 plan cannot also be used to claim education tax credits such as the American Opportunity Tax Credit or Lifetime Learning Credit.

IRS systems cross-check Form 1099-Q with Form 8863, and mismatches often result in automated notices being sent. These rules were not changed by the Tax Cuts and Jobs Act, the CARES Act, or the PATH Act, despite the expansion of education savings options.

Transfers And Other Accounts Have Limits

Some taxpayers believe education savings can be shifted freely between accounts. While tax-free rollovers and trustee-to-trustee transfers are allowed between certain 529 plans, the rules governing transfers to other account types are more nuanced than commonly understood.

Effective for distributions made after December 31, 2023, the SECURE 2.0 Act introduced a provision allowing a tax-free, direct trustee-to-trustee rollover from a 529 plan to a Roth IRA for the account beneficiary. To qualify, the rollover must not exceed the annual Roth IRA contribution limit, must stay within a $35,000 lifetime cap per beneficiary, must come from a 529 account that has been open for at least 15 years, and must not include contributions made within the five years before the distribution. Rollovers that do not meet all of these conditions may still result in tax consequences.

Transfers to ABLE accounts follow separate rules and should be reviewed against current IRS guidance before any transfer is made. Coverdell education savings accounts also follow separate contribution and usage rules.

School And Aid Reporting Creates Compliance Risks

Form 1098-T plays a central role in IRS oversight. Educational institutions report tuition payments and amounts received through a student aid program, which the IRS matches against education credit claims.

Returns are frequently flagged when claimed qualified higher education expenses exceed amounts reported by schools or when scholarships are not properly subtracted. Some states, including those with programs such as the Commonwealth Savers Plan, also provide education savings incentives that must be carefully coordinated with federal rules.

Loans, Technology, And Other Costs Add Complexity

Limited 529 withdrawals may be used for qualified education loan repayments, including certain student loan repayments, subject to a lifetime cap of $10,000 per individual. Separately, interest paid on student loans may be deductible, but it does not increase the pool of expenses eligible for 529 withdrawals or credits.

Costs for required computer technology and internet access may be eligible in certain situations, but optional or non-educational uses are not. Misclassifying these expenses is another common trigger for IRS notices.

Federal Oversight And Filing Guidance

The Internal Revenue Service operates under the Department of the Treasury, which oversees the enforcement of tax benefits related to education. The agency relies on standardized data and comparisons across plan years to identify discrepancies.

Tax professionals and accounting firms advise families to maintain detailed records, review IRS guidance, such as Notice 2015-5 and Notice 2018-58, and coordinate education savings strategies before filing to preserve tax advantages and minimize audit risk.

Sources

• IRS Topic No. 313 – Qualified Tuition Programs (529 Plans)
• IRS Instructions for Form 8863 – Education Credits
• IRS About Form 1098-T – Tuition Statement

By William Mc Lee, Editor-in-Chief & Tax Expert—Get Tax Relief Now