If You Use IRA Funds for College Expenses, Be Sure You Can Document It for the Tax Court
July 11, 2019
Distributions taken before an IRA owner reaches age 59½ are subject to a 10% early distribution penalty, unless an exception applies. For those who claim exceptions, it’s vital to maintain documented proof, as the IRS may deny the claim for exception in the absence of sufficient documentation. And that can be costly.
According to the National Center for Education Statistics (NCES), the average cost of college for an academic year can be over $39,000. Faced with the high costs of student loans and challenges with getting scholarships and grants, some individuals choose to take distributions from their retirement accounts to help defray higher education expenses. If those distributions are made before the account owner reaches age 59½, any tax deferred amount would not only be subject to income tax, but also an additional 10% tax (early distribution penalty). However, the penalty is waived if the IRA owner qualifies for an exception.
Individuals who plan to claim the higher education expenses exception must ensure that they have documented proof that the amount was in fact used to cover such expenses, so as to ensure that the IRS does not deny any claims for the exception.
Generally, distributions from IRAs are subject to ordinary income tax. If the distribution occurs while the IRA owner is under age 59½, an additional tax of 10% (early distribution penalty) applies to any taxable amount, unless an exception applies. One of the exceptions to the early distribution penalty applies to amounts used to cover qualified higher education expenses.
Qualified higher education expenses
Amounts used to pay for tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution
Expenses for special needs services in the case of a special needs beneficiary which are incurred in connection with enrollment or attendance
Expenses for the purchase of computer or peripheral equipment, computer software, or Internet access and related services, if such equipment, software, or services are to be used primarily by the beneficiary during any of the years the beneficiary is enrolled at an eligible educational institution
Room and board included for students who are at least half-time
Some caveats and exceptions apply. You should consult with your tax professionals, to identify amounts for which you can claim as qualified higher education expenses.
For this purpose, an eligible educational institution is generally any accredited college, university, vocational school, or other postsecondary educational institution; eligible to participate in a student aid program administered by the U.S. Department of Education.
An educational institution should be able to tell interested parties whether it meets the requirements to be considered an eligible educational institution.