NEWS
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.
Recent legislative changes have expanded the uses of a Section 529 plan, particularly for K-12 tuition and other elementary and secondary education expenses. Families can now withdraw up to $20,000 annually from 529 college savings plans to pay K-12 tuition at eligible elementary and secondary schools, in addition to college-related costs.
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.
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.
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, funds generally cannot be transferred into a Roth IRA or an ABLE account without tax consequences. Coverdell education savings accounts also follow separate contribution and usage rules.
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.
Limited 529 withdrawals may be used for qualified education loan repayments, including certain student loan repayments, subject to lifetime caps. 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.
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.
By William Mc Lee, Editor-in-Chief & Tax Expert—Get Tax Relief Now
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