What is a Qualified Higher Education Expense?

The withdrawal policies for the 529 plan have changed over the years. From once a relatively restrictive definition of "Qualified Higher Education Expense" or QHEE, it has become a more flexible plan due to the extensive work of advocates and legislators.

Money in a 529 account can always be withdrawn at any time for any reason, and that’s an important thing to remember. As to whether that withdrawal is tax- free, penalty-free, or taxable, that is now to be the question.

It is important that the account owners have a thorough understanding of what does and does not qualify because non-qualified withdrawals are subject to income tax as well as a penalty on the earnings portion of withdrawal raging to 10 percent. Every withdrawal includes an earnings portion in the distributions taken from a 529 plan between principal and earnings on a pro-rata basis.

What will be considered as qualified expenses?

Qualified expenses have five main categories:

• All expenses that are required by the school for enrollment or attendance at an institution such as tuition, fees, books, supplies, and equipment are all considered as qualified expenses. Drama club fees and other more which are not required by the school would be considered as non-qualified expenses.
• To be considered qualified, room and board which includes the costs of rent (whether living on or off-campus) and food must be less than or equal to the room and the boarding actual amount charged by the school if living in on-campus housing. The student would have to pay the difference using funds from another source if the total cost of living off-campus exceeds the student’s allowance. Regardless of whether they are on- or off-campus, the beneficiary must be enrolled at least half-time for room and board expenses to qualify.
• A recent change from the 2015 PATH Act considered computers, peripheral equipment, computer software, and internet access charges as qualified expenses for the benefit of 529 account owners. Now, the account owners can reimburse themselves for a laptop and printer without worry since the school hat to specifically require these items.
• Certain special needs services and equipment needed for enrollment or attendance of a beneficiary that has a disability may qualify. This includes transportation costs, as well as equipment such as wheelchairs or prosthetics. 
• Up to $10,000 for tuition at public, private, or religious K–12 schools are now considered qualified as a result of the 2017 Tax Cuts and Jobs Act. However, you need to be cautious depending on your state because this is limited to tuition only. The federal code for this expense is not conformed in every state. This means while your K-12 tuition withdrawal would be federally tax-free, the state may impose a tax on earnings and – potentially – claw back any prior state tax benefits taken. So prior to making a withdrawal for K-12 tuition expenses, you should contact your state and potentially, a tax professional first.

How about those considered as non- qualified expenses?

Tax liability will be given for those non-qualified expenses. Thus, you need to be sure to know what these are since there are some common expenses that do not really qualify and the definition of a qualified expense is intentionally broad.

• Travel – Cars, airfare, gas, transportation costs too and from the school do not qualify.
• Sports and activity fees – 529 accounts will not reimburse fees for extracurricular activities even if the beneficiary has a sports scholarship. Sports fees do not qualify.
• Student loans – Although several bills were proposed such as the SECURE Act to allow payback of student loans using 529 savings, still it is not allowed yet. Payback of student loans is still considered the non-qualified expense.
• Electronics – Electronics primarily used for entertainment such as projectors, home theatre equipment, photocopiers, and other electronics are not qualified unless they are specifically required by the school for enrollment or attendance.
• Insurance – Also non-qualified expenses: health insurance and medical expenses, including student health fees.
• To prevent “double-dipping” of federal tax benefits, expenses used to claim the American Opportunity Tax Credit (AOTC) or Lifetime Learning Credit – Expenses used to generate the AOTC or Lifetime Learning Credit are excluded from qualified expenses. Thus, this is considered as non-qualified.