There are many different IRS forms that begin with the numbers 1099. These are all information returns. An "information return" is not a tax return. Instead, it is a form that tells the IRS that you've received money from someone. The person or entity that paid you files the form with the IRS and gives you a copy.
Form 1099-Q is one of these information returns. It comes with the exciting title "Payments From Qualified Education Programs." You only need to worry about Form 1099-Q if you have a:
These accounts are to pay for higher education. Form 1099-Q reports distributions from these accounts to the IRS.
Coverdell ESA is short for Coverdell Education Savings Account. Originally known as the Education IRA, it was later renamed after Senator Paul Coverdell – who sponsored the legislation that introduced them. A Coverdell ESA is much like a Roth IRA except that it's only for education expenses. Here's how it works.
Qualified Tuition Programs are often called QTPs for short. They are also called "529 savings plans" after Section 529 of the tax code. QTPs are more complicated than Coverdell ESAs, but you can contribute much more money to them.
First of all, unlike Coverdell ESAs, QTPs states or state agencies must sponsor QTPs. Every state has some type of QTP; some have several. The states do not actually run their QTPs. Instead, investment companies manage them. You must pay annual fees to the management company. Here's how QTPs work:
You can take out the money in a Coverdell ESA or QTP account at any time. Withdrawals are tax-free so long as you use the money for ‚Äúqualified education expenses.‚Äù These include:
You can also spend up to $10,000 each year for the student to attend elementary or secondary school. This can include a private high school or parochial school.
It's important to keep track of how much in qualified education expenses you pay each year. If the total annual withdrawals from a Coverdell ESA and/or QTP are no more than these expenses, no tax is due on them. But, if you withdraw more than you spend for such expenses, a tax will be due on all or part of the withdrawn earnings. These earnings had been growing tax-free.
The financial institution, or whoever manages the higher education account, reports withdrawals from Coverdell ESA and QTP accounts will file Form 1099-Q. If the money went directly to the educational institution or student, the student receives the form. The parents or other account owner receives the form if the money went to them.
The deadline for filing Form 1099-Q is January 31. The account administrator files a copy with the IRS as well, so it knows about the withdrawals.
Box 1 of the 1099-Q lists the total annual distributions from the account. Box 2 lists the part of the distribution from account earnings. This amount can be taxable if not used for qualified education expenses. Box 3 lists the part representing the original contribution to the account. This amount is not taxable. The amount listed in Box 3 must equal Box 1 minus Box 2.
There is nothing on Form 1099-Q on how much you spent on higher education expenses. You need to keep track of this yourself.
You don't need to file Form 1099-Q with your tax return. Keep it with your tax records.
Students only to worry taxes on Coverdell or QTP withdrawals if the total amount taken out during the year is more than their qualified education expenses. In this event, the student must report part of the earnings portion as income on his or her Form 1040. The student may have to pay income tax on it plus a 10% penalty.
Example: Jacob has $12,000 in qualified education expenses during the year. His parents withdraw $36,000 from Jacob's QTP account. The $36,000 includes $6,000 in earnings. Jacob's parents use the money to pay his $12,000 qualified education expenses. They also buy him a car (not a qualified education expense).
Form 1099-Q, filed by the QTP administrator, shows $36,000 in distributions in Box 1, and $6,000 in earnings in Box 2. The $12,000 of qualified education expenses are only one-third of the QTP withdrawal. This means that only one-third of the withdrawn earnings, or $2,000, is tax-free. The remaining $4,000 is taxable.
Jacob must report the $4,000 on his Form 1040. He'll also have to pay a 10% tax penalty on the $4,000, or $400.
What if you withdraw money from both a Coverdell ESA and QTP the same year? You have to allocate your qualified education expenses between the two accounts.