Probate & Trust Law Section Conference Manual ... - Minnesota CLE

about the distributions, and she persuaded him that they should not withdraw the
money from the 529 accounts. Tim then informed a representative for the 529
plan that he did not wish to take the distributions. The representative told Tim
that because no error had been made by the program in processing his request for
distributions, the transactions could not be voided. The representative instructed
Tim to endorse the three checks and return them if he wished to redeposit the
amounts. Tim did so immediately.
When the 529 program received the three checks, it redeposited each one as a new
contribution into the same account from which it had been withdrawn.
Thereafter, Tim received a Form 1099-Q, Payments from Qualified Education
Programs (Under Sections 529 and 530), from the 529 plan for each of the three
distributions.
The IRS argued that the distributions were nonqualified distributions and that
even though the uncashed checks were returned to the program, they still
constituted nonqualified distributions followed by a recontribution. Further, the
recontributions did not qualify as rollovers. Therefore, income tax and the
additional penalty tax was assessed on the earnings portion of each distribution.
Tim argued that the distributions should not be considered to have been received
because he did not cash or deposit the checks, or alternatively that the
recontributions should constitute a rollover.
The Tax Court concluded that the receipt of a check, even though it is not cashed
or deposited, completed the distributions from the 529 accounts. The Tax Court
also found that when Tim returned the checks to be recredited to the accounts, it
did not constitute a valid rollover. In order to comply with the rollover rules, the
rollover either needs to be to an account for the benefit of a different beneficiary
or needs to be to a different program.
Had Tim consulted his tax counsel when he changed his mind, tax counsel might
have suggested that he establish new accounts under a different state program for
his children and deposit the proceeds from the distributions in the new accounts
within 60 days in order to comply with the rollover rules. Possibly, the rollover
rules would have been met even if Tim had simply directed that the distribution
from Child A’s account be deposited in Child B’s account, the distribution from
Child B’s account be deposited in Child C’s account, and that the distribution
from Child C’s account be deposited in Child A’s account.
The Tax Court feebly offered the consolation that Tim’s basis in each account
would be increased because of the “new” contribution to the account. The basis,
however, is irrelevant if the funds are ultimately used for qualified higher
education expenses.
The Tax Court did not address the gift tax consequences of the recontributions to
the accounts, presumably because the distributions were well within the limits of
the $13,000 gift tax annual exclusion, and presumably the taxpayer and his wife
27