If a college issues a refund of room and board charges, tuition or other fees paid for with 529 plan funds, you can return the money to your 529 plan to avoid having to pay taxes or a tax penalty on the refund.
The Protecting Americans From Tax Hikes Act of 2015 (PATH Act), which was enacted on December 18, 2015, added a special rule for recontribution of refunds to a 529 plan.
Recontribution of a Refund to a 529 Plan
If the beneficiary or account owner of a 529 plan receives a refund of qualified higher education expenses from the college or university that were paid for with a 529 plan distribution, the refund can be recontributed to the 529 plan within 60 days of the date of the refund without having to pay any taxes and penalties on the distribution.
The amount of the recontribution cannot exceed the refunded amount. Otherwise, any excess amount will be considered to be a new contribution, not a recontribution.
The recontribution is treated entirely as principal, as opposed to a mix of principal and earnings. The recontribution will not be counted against the beneficiary’s aggregate contribution limit.
The refund must be recontributed to a 529 plan for the same beneficiary, but it does not necessarily need to be recontributed to the same 529 plan from which it was distributed.
Similar rules apply to other qualified tuition programs, such as prepaid tuition plans and Coverdell education savings accounts, not just 529 college savings plans.
What If the Refund Is Not Recontributed?
If the refund is not recontributed, it will be considered a non-qualified distribution. The earnings portion of a non-qualified distribution is subject to income taxes at the beneficiary’s rate and a 10% tax penalty. There may also be recapture of state income tax breaks attributable to the non-qualified distribution.
Alternatives to Recontributing a Refund
Another option is to look for other qualified expenses in the same tax year that can justify the distribution as a qualify distribution. For example, if a student gets a prorated room and board refund because the college told the students to vacate the dorms, but then buys a computer and pays for internet access because the college moved classes online, they might be okay, since computer equipment, peripherals, software and internet access are qualified higher education expenses for 529 plans.
What About “Coupon” Refunds?
Some colleges provide refunds of tuition and fees, room and board, and other college charges as vouchers or credits toward future college costs.
These “coupon refunds” cost the colleges much less than providing a cash refund. They have negligible financial value to most students because they are considered to be estimated financial assistance (EFA), which reduces the student’s financial need and, consequently, the student’s eligibility for need-based financial aid.
Since a coupon refund does not yield a cash payment to the student, they cannot be recontributed to a 529 plan. Since a coupon refund is not a true refund, it does not cause the 529 plan distribution to become non-qualified.