Rolled tax form 1040

Dear Tax Talk,
My husband took a withdrawal from his Coverdell Education Savings Account and used it for non-education expenses. He thinks he needs to do a quarterly report for the IRS, but I think he just needs to claim it as income on his end-of-the-year taxes on Form 1040.
— Sallie

Dear Sallie,
You have two issues that need to be resolved before your question can be answered. The first issue is determining how much of the distribution is going to be taxable. The second issue involves the requirements for making quarterly estimated tax payments to the IRS. Let’s take them one at a time to see what your answer will be.

First of all, a Coverdell Education Savings Account, or Coverdell ESA, is an account set up for a designated beneficiary to be used for qualified education expenses. Contributions grow tax-free until they are distributed. Distributions that exceed the beneficiary’s qualified education expenses are known as “excess distributions,” and they are taxable to the extent that they include earnings that have accumulated tax-free in the account. You should contact the investment company who handles this account and find out what that earnings number is so you can determine how much additional tax you may owe.

Additionally, the general rule is that you must pay a 10 percent additional tax on the taxable distributions you receive unless you meet one of the six exceptions. You will need to complete IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. The exceptions are all listed in the instructions, so you might want to take a look at the list.

Characteristics of a Coverdell ESA

Now for the second issue: Once you figure out how much of the distribution is taxable and whether or not you are subject to the 10 percent additional tax, you can determine if you need to send in a quarterly estimated tax payment using Form 1040ES. The general rule is that if you have had at least 100 percent of your 2014 tax liability paid in through withholding or “refundable credits” when you file your 2015 Form 1040, you don’t need to worry about “underpayment of tax” penalties, as long as it is paid by April 15, 2016. There are numerous exceptions to this general rule, so you may want to take a look at the estimated tax payment requirements if that is not your case.

Thanks for the great question and all the best to you and your husband.

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