Are Distributions Taxable?

The part of a distribution representing the amount paid or contributed to a tuition plan does not have to be included in income. This is a return of the investment in the plan.

Generally, for 2001, the beneficiary must include in income any earnings distributed from a QSTP. The beneficiary does not have to include in income any return of the investment in the plan.

Generally, for 2002, the beneficiary does not have to include in income any earnings distributed from a QTP established and maintained by a state (or an agency or instrumentality of the state) if the earnings are used for higher education. However, the beneficiary must include in income any earnings distributed from a QTP if the plan was established and maintained by one or more educational institutions. The beneficiary does not have to include in income any return of the investment in the plan.

Determining earnings and return of investment. If you received a distribution in 2001, how you determine the part of the distribution that is earnings and the part that is a return of investment in the plan depends on whether:

  1. Contributions were made to an account established to meet the qualified higher education expenses of a designated beneficiary, or
  2. Tuition credits or certificates were purchased that entitle a designated beneficiary to the waiver or payment of his or her qualified higher education expenses.

In-kind distributions. Any in-kind distribution (such as a waiver of tuition) furnished to a designated beneficiary under a QTP is considered a distribution to the beneficiary.

Distributions From Account

If contributions were made to an account established to meet the qualified higher education expenses of a beneficiary, you determine the part of any distribution that is earnings by:

  1. Dividing the amount of the distribution by the account balance as of the end of the year (including all amounts distributed during the year), and then
  2. Multiplying the result of (1) by the earnings in the account as of the end of the year (including all earnings distributed during the year).

The remaining portion of the distribution is a tax-free return of investment.

Example. In 1996, your parents opened a college savings account with a QTP on your behalf. Your parents contributed $18,000 to the account, including processing fees. On December 31, 2001, the balance in the account is $24,000 (including amounts distributed in 2001).

In 2001, you enrolled at a 4-year university. The QTP made distributions on your behalf to the university in August for the fall semester and in December for the spring semester. Tuition for full-time attendance at the university is $6,600 for the academic year. The only expense covered by the QTP distributions was tuition.

You figure the part of the distributions that is earnings by:

  1. Dividing the amount of the distributions ($6,600) by the account balance as of the end of the year ($24,000, which includes all amounts distributed during the year), and then
  2. Multiplying the result (.275) by the earnings in the account as of the end of the year ($6,000, which includes all earnings distributed during the year).

The earnings are $1,650. This is illustrated in Worksheet 8-1.

Worksheet 8-1. Earnings Part of                Distributions                From Account

1. Distributions in 2001   $ 6,600  
2. Account balance as of 12/31/2001   24,000  
3. Divide line 1 by line 2   .275  
4. Earnings as of 12/31/2001   6,000  
5. Multiply line 3 by line 4. This is the part of the 2001 distributions that is earnings   $ 1,650  

Distributions Related To Credits or Certificates

If tuition credits or certificates were purchased that entitle the beneficiary to the waiver or payment of qualified higher education expenses, the part of any distribution that is earnings is the value, at the time of distribution, of the credits, hours, or other units of education distributed minus the return of investment portion of the distribution. The value of the credits, hours, or other units of education may be based on the tuition received or the cash distributed.

You determine the return of investment portion of the distribution by:

  1. Dividing the investment in the account at the end of the year in which the distribution is made (including any return of investment made during the year) by the number of credits, hours, or other units of education in the account at the end of the calendar year (including all credits, hours, or other units of education distributed during the calendar year), and then
  2. Multiplying the result of (1) by the number of credits, hours, or other units of education distributed during the current calendar year.

Example. In 1996, your parents opened a QTP account on your behalf. Through the account they purchased eight units of education equivalent to eight semesters of tuition for full-time attendance at a public 4-year university covered by the QTP. They contributed $16,000 ($2,000 for each unit) that included payment of processing fees.

In 2001, you enrolled at the university. The QTP made distributions on your behalf to the university in August for the fall semester and in December for the spring semester. Tuition for full-time attendance at the university is $5,200 for the academic year. The only expense covered by the QTP distributions was tuition.

To figure the earnings part of the distribution, you must figure the return of investment portion and subtract that amount from the current value of the distributed units.

You figure the part of the distributions that is a return of your parents' investment by:

  1. Dividing the investment in the account at the end of the year in which the distribution is made ($16,000 -- which includes any return of investment made during the year) by the number of credits, hours, or other units of education in the account at the end of the calendar year (8 -- which includes all credits, hours, or other units of education distributed during the calendar year), and then
  2. Multiplying the result of (1) by the number of credits, hours, or other units of education distributed during the current calendar year (2).

You then subtract the result of (2) above from the current value of the distributed units.

This is illustrated in Worksheet 8-2.

Worksheet 8-2. Earnings Part of                Distributions Related                To Credits or Certificates

1. Current value of 2 units distributed in 2001   $ 5,200  
2. Investment in the account as of 12/31/2001   16,000  
3. Number of units in account as of 12/31/2001   8  
4. Divide line 2 by line 3. This is the per unit investment   2,000  
5. Number of units distributed in 2001   2  
6. Multiply line 4 by line 5. This is the investment portion of the 2001 distributions   4,000  
7. Subtract line 6 from line 1. This is the part of the 2001 distributions that is earnings   $ 1,200