Who Pays Taxes on 529 Withdrawals and the 10% Penalty

On a 529 plan withdrawal, the person listed as the recipient on Form 1099-Q is the one who pays taxes on 529 withdrawals, and only if the money didn’t go toward qualified education expenses. When it does, nobody owes federal income tax on the earnings. When it doesn’t, the earnings portion is taxed as ordinary income to that recipient, and an additional 10% federal penalty usually applies on top.

The Payee on Form 1099-Q Is the Taxpayer

When you request a distribution, you choose where the money goes: to the school, to the student, or to yourself as the account owner. That choice sets who the IRS treats as the payee, and the payee is the person who receives Form 1099-Q and carries any tax consequences.

If the check goes to the school or to the student, the beneficiary is the payee. If the account owner takes the distribution as a reimbursement, the owner is the payee.¹ Whoever is named reports any taxable earnings on their own return. That distinction can matter in dollars: a student with little other income often sits in a much lower bracket than a parent, so routing the distribution through the student can shrink the tax bill on a withdrawal that turns out to be partly non-qualified.

What Is Actually Taxed

Every 529 distribution is part original contributions and part investment earnings. Contributions went in with after-tax dollars, so they never get taxed again no matter how the money is spent.² Only the earnings portion is at risk.

When the withdrawal covers qualified education expenses, those earnings come out tax-free. When it doesn’t, two things happen to the earnings, and both fall on the payee: ordinary income tax at the payee’s rate, plus a 10% federal penalty.² On a $5,000 withdrawal containing $1,500 of earnings that pays for nothing qualified, the payee owes income tax on the $1,500 plus a $150 penalty.

State taxes can add another layer. More than 30 states offer an income tax deduction or credit for 529 contributions, and many of those states require you to “recapture” that benefit when you take a non-qualified withdrawal, meaning you repay the tax break you claimed earlier. The rules vary, so check your state’s tax authority before pulling money out for anything other than education.

When the Withdrawal Is Fully Tax-Free

The earnings escape tax entirely when the money pays for qualified expenses. That category is broad: tuition and required fees at eligible postsecondary institutions; books, supplies, and equipment including computers and internet used by the student during enrollment; room and board for students enrolled at least half-time, capped at the school’s published cost-of-attendance figure or the actual on-campus charge;³ up to $10,000 per year of K-12 tuition;² fees, books, and equipment for apprenticeship programs registered with the U.S. Department of Labor;⁴ and up to $10,000 in lifetime student loan repayment for the beneficiary, with a separate $10,000 cap available for each of the beneficiary’s siblings.⁵

One timing rule trips people up every year. The withdrawal and the expense it pays for must fall in the same calendar year, not the same academic year. A tuition bill paid in December needs a matching 529 distribution taken by December 31. Wait until January and the IRS treats the withdrawal as a mismatch, which turns an otherwise qualified withdrawal into a taxable one.

When the 10% Penalty Is Waived but Tax Still Applies

Several situations let you skip the penalty even when the withdrawal isn’t qualified. Income tax on the earnings still applies in each case; only the extra 10% disappears.

Scholarships. If the beneficiary receives a tax-free scholarship, you can pull an amount up to the scholarship without the penalty. The earnings within that amount are still taxable income to the payee.
Death or disability of the beneficiary.
Attendance at a U.S. military academy, up to the cost of attendance at the academy.
Amounts made taxable only because the same expenses were used to claim the American Opportunity Tax Credit or Lifetime Learning Credit.⁶

The scholarship exception is the one that comes up most. A student who earns a $5,000 scholarship can withdraw $5,000 from the 529 for non-education spending and pay only the income tax on any earnings inside that amount. The penalty is waived dollar-for-dollar up to the scholarship value.

How Education Credits Reduce the Tax-Free Room

The American Opportunity Tax Credit and the Lifetime Learning Credit can each save a family real money, but you can’t use the same expense to claim a credit and to justify a tax-free 529 withdrawal. This is the no-double-benefit rule, and it’s where a lot of 529 planning goes sideways.

The math works like this: start with total qualified expenses, subtract any tax-free assistance the student received (scholarships, grants, employer tuition benefits), then subtract whatever amount you used to claim an education credit. What’s left is the pool of expenses that can support a tax-free 529 withdrawal.⁷

Say a student has $12,000 in qualified expenses, receives a $3,000 scholarship, and the family claims the AOTC using $4,000 of expenses. The expenses available for a tax-free 529 withdrawal drop to $5,000. Withdraw more than that and the excess earnings become taxable to the payee. Earnings made taxable purely because the expenses were routed to a credit escape the 10% penalty.⁶ The AOTC alone can be worth up to $2,500 per student per year, so the ordering usually still comes out ahead.

How to Report It

The plan administrator sends Form 1099-Q to the payee by January 31 following the year of the withdrawal. Box 1 shows the gross distribution, Box 2 the earnings, and Box 3 the basis.¹

If qualified expenses equal or exceed the gross distribution, you generally don’t report anything as income; the tax-free treatment is the default. If the distribution exceeds qualified expenses, the taxable portion of the earnings is calculated using the ratio of earnings to the total distribution, applied to the non-qualified share, and reported on Schedule 1, Line 8(z) of Form 1040. The 10% penalty, when it applies, is calculated on Form 5329 and carried to the 1040.⁶

The IRS doesn’t receive a separate report of your qualified expenses. The burden of showing the withdrawal was tax-free sits on the payee, so keep tuition bills, receipts, and housing invoices for at least three years after filing.

Ways to Avoid Owing Anything at All

If the beneficiary doesn’t need the money, you don’t have to take a taxable withdrawal to get it out of the plan. Two options avoid tax entirely.

Change the beneficiary. Switching the account to another qualifying family member triggers no income tax, no penalty, and no reporting requirement.² The IRS definition of qualifying family member is broad, covering the current beneficiary’s spouse, children, grandchildren, parents, grandparents, siblings, stepchildren, in-laws, aunts, uncles, nieces, nephews, and first cousins.

Roll leftover funds to a Roth IRA. Starting in 2024, a beneficiary with unused 529 money can move some of it to their own Roth IRA tax-free and penalty-free. The 529 account must have been open for at least 15 years for the current beneficiary, only contributions and earnings that have been in the account for at least five years qualify, the transfer must go directly between trustees, and the beneficiary must have earned income for the year.⁵ The annual rollover is capped at the Roth contribution limit, $7,500 for 2026, less any other IRA contributions the beneficiary made that year,⁸ and the lifetime cap per beneficiary is $35,000. Moving the full amount takes at least five years.

1
Internal Revenue Service. Instructions for Form 1099-Q
2
Internal Revenue Service. 529 Plans: Questions and Answers
3
Legal Information Institute. Definition: Qualified Higher Education Expenses From 26 USC 529(e)(3)(A)
4
Internal Revenue Service. Topic No. 313, Qualified Tuition Programs (QTPs)
5
Office of the Law Revision Counsel. 26 USC 529 – Qualified Tuition Programs
6
Internal Revenue Service. 1099-Q What Do I Do?
7
Internal Revenue Service. Publication 970 (2025), Tax Benefits for Education
8
Internal Revenue Service. 401(k) Limit Increases to $24,500 for 2026; IRA Limit Increases to $7,500