Transferring Coverdell ESA's to 529 plans, tax consequences / headaches...

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Transferring Coverdell ESA's to 529 plans, tax consequences / headaches...

Post by UncleLongHair » Wed Jan 17, 2018 4:56 pm

I've read the wiki and a bunch of other articles about this but don't think I understand everything. Any info welcome.

I've been contributing to Coverdell ESA's for the 2 kids since 2005, total contributions $22k. However, I screwed up because in some of those years my MAGI was above the limit allowed for Coverdell contributions. It was one of those things where I just started doing it every year but our income increased and I didn't realize I was over the limit.

I understand I can be subject to a 6% penalty on the excess contributions PER YEAR and need to get the funds out of those accounts. My plan is to roll them into 529 plan accounts, which I already have for both kids.

I understand I have to give the 529 plan a breakdown of principal and gains for each contribution, because they can be taxed differently if I make a non-qualifying distribution from the 529 plan. My questions:

1) My state gives a state income tax break for 529 contributions, will I get that for these contributions?
2) My understanding is that gains from either plan are not taxed as long as they are used for qualified expenses (i.e. school expenses), so is the breakdown of principal/gains from the Coverdell account only needed/used if I make non-qualified distributions?

I asked these questions of the 529 plan administrator and they said to consult a tax professional, and the tax guy I talked to told me to contact my 529 plan administrator...

Now as for the tax penalties. I understand I will be subject to a 6% penalty each year for excess contributions and this should be reported on form 5329. Is this just on contributions or total account value each year? If it is just contributions, could I transfer only the amount of the contributions and leave the gains in those accounts? How far back do I have to correct this, all the way back to 2005? I hate to sound like Al Capone, but if the IRS has not noticed this yet after 12 years, will they ever notice? The kids will be in college in a few years and I'll be spending the accounts...

I understand that I screwed up by contributing to these plans but these fees could be in the $1000's for me which really cuts into the college savings, and I basically chose one of two plans that offer the same tax savings, and chose the wrong one and will pay hefty penalties. It isn't like the IRS missed out on any tax revenue. Is there any way to get this reduced/abated?

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