ESA Brochures & Forms
ESA Brochure (.pdf)
IRS Form 5305-E (.pdf)
ESA Distribution
Form (.pdf)
Named Education IRAs when first established in 1998, these accounts were renamed Coverdell Education Savings Accounts (ESA) in July 2001. (Despite the original name, education IRAs had nothing to do with retirement). The ESA is a tax-favored account for the purpose of saving for education expenses. ESAs allow contributions for any child under age 18, and tax-free distributions for a broad variety of education expenses up until age 30.
Summary
A Coverdell Education Savings Account (ESA) is a tax-exempt trust created in the United States for the sole purpose of paying the qualified education expenses
of the designated beneficiary. No contribution may be accepted by the ESA after the beneficiary attains age 18. Annual contributions to the ESA may not exceed
$2,000 (eligible contributions may be less if the taxpayerÍs income exceeds certain thresholds). All contributions must be in cash. As with an IRA, an ESA will
lose its tax-exempt status if it is used in a prohibited transaction.
Contributions
Aggregate contributions that may be made by all contributors to one or more ESAs established on behalf of any particular beneficiary is limited to $2,000 for
each year. Corporations, tax-exempt organizations and other entities may make contributions to an unlimited number of partiesÍ ESAs, so long as they do not
contribute more than $2,000 to any particular beneficiary.
The maximum income that joint tax return filers can report and still make a full contribution to an ESA is $190,000. For incomes up to $220,000, lesser contributions can be made. For single filers, the full contribution income limit is $95,000, phasing out at $110,000.
Contributions to an ESA may be made up to April 15th (the tax return due date, not including extensions) for a contribution to apply to the preceding year. Any contribution to an ESA is treated as a gift from the contributor to the beneficiary at the time of the contribution, meaning annual contributions are eligible for the gift tax exclusion and are excludable for purposes of the generation-skipping transfer tax.
A 6% excise applies to excess contributions, that is, those that are:
- More than a total of $2,000 per designated beneficiary per year;
- Made in a year when the contributorÍs adjusted gross income tops the limits for income eligibility;
- Contributed to a designated beneficiary who is 18 years of age or older;
- Made in violation of applicable rollover rules.
Excess contributions, if corrected in a timely manner, will avoid the penalty.
Distributions
Distributions from ESAs are tax-free provided that they are used to pay the beneficiaryÍs qualified education expenses. Tuition, fees, books, supplies, and
equipment required for attendance at an eligible educational institution are qualified expenses. The term includes room and board expenses, if (1) the
beneficiary is enrolled in a program leading to a recognized educational credential and (2) the student carries at least one-half the normal full-time work
load for a chosen course of study.
New rules allow you to use the Education Savings Account to pay for elementary and secondary expenses at private, public, or religious schools. This includes academic tutoring, computer technology or equipment (such as internet services), room and board, transportation, uniforms, supplemental items and services (including extended day care), and special needs services in the case of a special needs beneficiary. Additional exceptions are available to special needs students. Qualified education expenses are reduced by the amount of any scholarships or financial aid received.
Taxpayers may claim the HOPE Scholarship Credit or the Lifetime Learning Credit in the same year that a tax-free distribution is made from an ESA. However, the distributions cannot cover the same education expense.
Because contributions to ESAs are treated as gifts, distributions from the accounts are made only to beneficiaries. Distributions of ESAs are excludable from gross income to the extent that the distribution does not exceed the qualified education expenses incurred by the beneficiary during the year in which the distribution is made. Distributions are tax exempt regardless of whether the beneficiary attends an education institution on a full-time or half-time basis.
Distributions in amounts greater than allowed tax-free are taxed under IRS Code Section 72 annuity rules. There is an additional 10% tax imposed on any taxpayer who receives an ESA distribution that is includable in gross income, with certain exceptions.
Amounts remaining in an eduction savings account may be rolled over into another ESA for the education of another beneficiary in the beneficiaryÍs family. Similarly, any change in beneficiary does not constitute a distribution if the new beneficiary is a member of the family of the original beneficiary. A personÍs family members are determined under IRS Code Section 529(e)(2). Alternatively, assets remaining in the ESA may be distributed to the original beneficiary who must include the earnings component of the distribution in income and pay a 10% penalty.
Termination
The balance remaining in an ESA must be distributed within 30 days after a beneficiary reaches age 30. Also, distribution of the account balance of a deceased
beneficiary must be made within 30 days after the death of a beneficiary under age 30. Where such a distribution is required, the balance at the close of the
30-day period is deemed to be distributed at that time.
Responsible Party
The person who controls the ESA is the ñresponsible partyî as named in the account agreement. The responsible party typically is the parent or guardian of the
beneficiary.
HOPE Scholarship Credit
Although not part of the Education Savings Account legislation, the HOPE Scholarship Credit relates to the ESA. Taxpayers may be able to claim a non-refundable
HOPE Scholarship Credit against their federal income taxes. The credit is claimed for the qualified tuition and related expenses of each student in the
taxpayerÍs family who is enrolled at least half-time in one of the first two years of post secondary education and who is enrolled in a program leading to a
recognized educational credential. The amount that may be claimed as a credit is generally equal to: (1) 100% of the first $1,000 of the expenses, plus (2)
50% of the next $1,000 of the taxpayerÍs out-of-pocket expenses for each studentÍs qualified tuition and related expenses. Thus, the maximum credit a taxpayer
may claim for a taxable year is $1,500 multiplied by the number of students in the family who meet the enrollment criteria described. The amount a taxpayer may
claim is gradually reduced for taxpayers with modified gross incomes above $40,000 ($80,000 for joint filers), and phased out at $50,000 ($100,000 for joint
filers).
Lifetime Learning Credit
Similarly, the Lifetime Learning Credit also relates to the ESA. Taxpayers may be able to claim a non-refundable Lifetime Learning Credit against their federal
income taxes. The credit is claimed for the qualified tuition and related expenses of each student in the taxpayerÍs family who is enrolled in eligible
education institutions. Unlike the HOPE Scholarship Credit, students are not required to be enrolled at least half-time in one of the first two years of post
secondary education. The amount that may be claimed as a credit is equal to 20% of the taxpayerÍs first $10,000 of out-of-pocket qualified tuition and other
expenses for all the students in the family. The amount a taxpayer may claim is gradually reduced for taxpayers with modified gross incomes above $40,000
($80,000 for joint filers), and phased out at $50,000 ($100,000 for joint filers).
