529 Rollover to Roth IRA for California Beneficiary

[stuper1]

I just found out that California is not participating in the new rule allowing 529 rollovers to a Roth IRA for a beneficiary. I am not clear on what this means for the case where the 529 owner (grandparent) lives outside California but the beneficiary (grandson) lives in California. Here is what I have found:

"For California taxpayers, a rollover from a 529 plan account to a Roth IRA will be treated as a non-qualified withdrawal and the earnings portion of the withdrawal will be subject to California state income tax, including the additional 2.5% California tax on non-qualified withdrawals."

In our case the grandparent who owns the 529 lives outside California, and my son lives in California. Is my son going to have to pay California state income tax plus a 2.5% penalty on the 529 money if it gets rolled over to his Roth IRA? I note that the language above focuses on the "withdrawal". Does that mean that the state income tax and penalty only apply if the 529 owner, who is withdrawing the money to give to the beneficiary, lives in California? In other words, is it only the owner who is subject to the California income tax and penalty, or is it also the beneficiary? If the state income tax and penalty only apply to the owner, and if the owner lives outside California, then it seems no state income tax or penalty would be due.

Does anyone know the answer? Please no speculation, unless it is based on at least a bit of reasonable deduction. There is too much unwarranted speculation in this forum sometimes, which muddies the waters in trying to reach a consensus.

[stuper1]

After further reading on the subject, I believe it's the 529 account owner who is potentially subject to the California state income tax and penalty, not the 529 beneficiary. Therefore, if the owner is outside California and rolls the 529 money into the California beneficiary's Roth IRA, then the owner won't owe California tax (because he lives outside California) and the beneficiary also won't owe California tax (because he basically just received a gift that he put into his Roth IRA -- fyi, my son has a job and thus has earned income, so he is eligible to contribute to a Roth IRA -- and money is fungible).

What do you think? Am I looking at this the right way?

[bz776]

Sadly, I suspect that this would be taxable to the CA beneficiary. Non-qualified distributions are taxed to the recipient, so if the withdrawal is paid to the grandparent, then it would be taxed with regard to their state's code. But since the 529 Roth conversion/rollover is required to be sent trustee-to-trustee, it's going to have to go directly to an account which has already been opened in the beneficiary's name. Hence, I think most likely similarly taxable as the Fed code for non-qualified distributions.

One thing to note is that the principal is not itself subject to tax nor the 2.5% penalty. Only the earnings are taxed/penalized on non-qualified distribution. Also, if you son has received any non-taxable scholarship aid, those amounts can be withdrawn without penalty, though the earnings do remain taxed.

https://www.savingforcollege.com/articl ... stribution

[Tinroofsundae]

Any update? I am facing this exact situation. Beneficiary is in California, account owner is in a state which follows federal guidelines allowing 529 to Roth IRA conversion. So this info would be very helpful for filing taxes. Thanks!