5909 coverdell esa - ascensus

Coverdell ESACompliance & Operations

The material used in this text has been drawn from sources believed to be reliable. Every effort has been made to assure the accuracy of the material; however, the accuracy of this information is not guaranteed. The IRS forms and laws are often changed without prior notice from the government. The Coverdell ESA Compliance & Operations manual is sold with the understanding that the publisher and the editor are not engaging in the practice of law or accounting.

The text addresses most ESA compliance topics. However, it may occasionally be necessary to refer to a more comprehensive text or other source to answer some questions. If you are unsure of an answer, consult a competent professional.

#5909 V.2022-January (12/2021)Ascensus® and the Ascensus logo are registered trademarks of Ascensus, LLC. Copyright ©2022 Ascensus, LLC. All Rights Reserved. www.ascensus.com

This material may not be reproduced in whole or in part in any form or by any means without written permission from the publisher.

Copyright is not claimed on any material from official U.S. government sources.

Printed in the United States of America.

Table of Contents • i

Table of Contents

Chapter 1Introduction to Coverdell ESAsOverview . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .1

ESA Origins . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2General Requirements . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2ESA Advantages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .2

Government Resources for ESAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3Internal Revenue Code. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4Treasury Regulations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4Revenue Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4Revenue Rulings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4IRS Announcements and Notices . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .4IRS Publications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5IRS Forms. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5Private Letter Rulings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Organizations That May Offer ESAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5

Parties Involved With ESAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .5Financial Organization . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6Designated Beneficiary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6Grantor/Depositor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6Responsible Individual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6Contributor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .6Family Member . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7Death Beneficiary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7

ESA Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7Financial Organization Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .7Designated Beneficiary Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .8

Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9Financial Organization Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9

Plan Establishment. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .9Amendments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10

Grantor/Depositor Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10Responsible Individual Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .10Designated Beneficiary Responsibilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11Contributor Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11Death Beneficiary Responsibilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .11Summary of Roles and Responsibilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .12

ii • Table of Contents

Chapter 2Opening an ESAOpening Documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15

Plan Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .15No Prototype Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16Proof of Plan Agreement Receipt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16Contents of the Plan Agreement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16

Article I . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .16Article II . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Article III . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Article IV . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Article V . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Article VI . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Article VII . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Article VIII . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Article IX . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17Article X . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .17

Disclosure Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18

Document Amendments. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18

Identifying Involved Parties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .18Grantor/Depositor . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19Designated Beneficiary. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19Responsible Individual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19

Death of Responsible Individual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19Designated Beneficiary as Responsible Individual . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .19Death of Designated Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

Death Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

Customer Identification Program . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .20

Contribution Information. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

Certification of Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

Investment Selection. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .21

Compliance Check . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .22

Coverdell ESA Opening Documents Log Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .23

Chapter 3ESA ContributionsRegular Contributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27

Contribution Limit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .27Contributions in Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28

Contribution Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28Designated Beneficiary Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28Contributor Eligibility . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28

Contributor Income . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .28Phase-Out Range for Single Filers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29Phase-Out Range for Joint Filers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .29

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Contribution Deadline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30Extensions for Military Personnel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .30Extensions for Disaster Area Victims. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31

Regular Contribution Procedures. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .31Contribution Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32

Transfers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .32Qualified Family Members . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33ESA Transfers Reported to IRS . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33Unlimited Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33Death of Designated Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33Divorce . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33Transfer Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .33

Rollovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34Who May Receive Rollovers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .34Election to Change the Designated Beneficiary . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35Rollovers Must Be in Cash . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .3560-Day Rule. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35One-Per-12-Month Rule. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35Rollovers From Other Sources. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .35

Savings Bonds . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36Military-Related Death Payments . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36

Reporting ESA Rollovers. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36Rollover Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .36

Tracking Basis and Earnings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37Reporting Relief . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .37Basis and Earnings Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .38


Coverdell ESA Contribution Log Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .39

Coverdell ESA Investment Log Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .43

Chapter 4ESA DistributionsTaxation of ESA Distributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45

Penalty Tax Exceptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .45Prohibited Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46

Qualified and Nonqualified Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46Qualified Education Expenses. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .46

At Least Half-Time Student . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .47Eligible Educational Institution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48Room and Board Expense . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48Qualified Tuition Programs. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Additional Deduction or Credit . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48Nonqualified Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .48

Correcting Excess Contributions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .49Types of Excesses . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50Correcting Excess Contributions to Avoid the Penalty Tax . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50

iv • Table of Contents

Calculating the NIA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .50NIA Clarifications . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51Reporting Excess Removal Before the Applicable Deadline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .51

Excess Contributions Removed After the Applicable Deadline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52Determining the Amount of the Excess Contribution . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52Applying an Excess Contribution to the Following Year . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .52

Terminating ESAs Upon Age 30 . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53

Death Beneficiary Distributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53Reporting Distributions to Death Beneficiaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .53

Distribution Procedures . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54No Income Tax Withholding . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .54


Coverdell ESA Distribution Log Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .55

Chapter 5ESA ReportingReporting Requirements. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57

Who Receives Required Reports . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .57Reporting Deadlines. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58

ESA Reporting Timeline . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58How to Receive a Filing Extension . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .58

Method of Submitting Extension Request . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59Automatic 30-Day Extension . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59Required Information . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59Filing Extensions for Recipient Copies. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .59

Methods of Filing Information Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60Transmittal Forms for Paper Reporting . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60Electronic Filing of Information Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .60Substitute Forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61Truncating Identification Numbers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .61

IRS Form 5498-ESA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .612021 Form 5498-ESA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62Penalty for Failure to Timely Provide Form 5498-ESA . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62

IRS Form 1099-Q . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .62Form 1099-Q . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63Earnings and Basis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .63Trustee-to-Trustee Transfers . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64Optional Distribution Codes. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .64Reporting Excess Contributions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65Penalty for Failure to Timely File Form 1099-Q . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65

Reporting Corrections. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65Correction Methods. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .65Correction Example . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67Reporting Incorrect Payer Name and/or TIN . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .67

Table of Contents • v

Year-End Statement . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .68


2021 Coverdell ESA Reporting Activity Log Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .69

Chapter 6Miscellaneous ComplianceESA Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71

Sales Charges and Commissions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71Administrative Fees . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .71

Prohibited Transactions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72Prohibited Transactions Involving Disqualified Persons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72

Disqualified Persons . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .72Transactions. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73

Loans. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73Collectibles and Life Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73Banking-Related Services Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .73Relationship Brokerage Services Exemption . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74Prohibited Transaction Exemptions Added for ESAs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74

Investment Advice. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .74Department of Labor’s Prohibited Transaction Exemption 2020-02 . . . . . . . . . . . . . . . . . . . . . . . . . . . .74

Impartial Conduct Standards . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75Additional Guidance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .75

SEC Best Interest Standard for Broker-Dealers, Registered Investment Advisors . . . . . . . . . . . . . . . . . . .75

Divorce . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .76

ESA File Maintenance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77ESA File Contents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .77ESA Master File . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78

Opening Documents . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78Transaction Forms . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78Amendment Files. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .78

Record Retention . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79Documentation to Retain. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79Maintaining Records Electronically . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79Length of Time to Keep Records . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .79

IRS Information Returns . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .80Penalties . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .80


Individual Compliance Survey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .81

Coverdell ESA Forms Log Sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .85

Glossary of Terms

vi • Table of Contents

Introduction

The primary purpose of the Coverdell ESA Compliance & Operations manual is to present practical information on ESAs in a logical, understandable format. The information is derived from many sources—including federal statutes, regulations and rulings, and direct conversations with IRS representatives. Note that state laws are not covered in this manual. Financial organizations should check with their organizations’ legal advisors for any state law concerns that would affect their ESA programs.

Supporting IRS guidance (e.g., forms, Internal Revenue Code sections, Treasury regulations) are sometimes referenced for additional background information. These items can be found by clicking on hyperlinks within this manual or are otherwise searchable at www.irs.gov.

NOTE: Hyperlinks to externally hosted forms on the IRS website generally go to the version identified by the IRS as the most current version of the form, unless there is some instructional value to linking to a specific year’s form. When linking out to an external IRS form, please verify that you’ve reached the version you intended, in case the IRS updates its URL addresses before the next update of this manual.

For information on industry and regulatory news, visit ascensus.com.

vii • Using This Manual

http://www.irs.gov

http://ascensus.com

viii • Using This Manual

Chapter 1

Introduction to Coverdell ESAsOverview

Government Resources for ESAs

Organizations That May Offer ESAs

Parties Involved With ESAs

ESA Penalties

Responsibilities

Overview

Congress created Coverdell education savings accounts (ESAs) under Internal Revenue Code Section (IRC Sec.) 530 with passage of the Taxpayer Relief Act of 1997 (TRA-97). ESAs, formerly called “Education IRAs,” are a tax-favored tool for parents and students to save for education expenses. ESAs are one of two saving vehicles designed specifically for education—the other is qualified tuition programs (QTPs). Both allow parents and other persons to start saving for a child’s education early (even at birth), allowing for many years to compound interest. Contributions can be made to both ESAs and QTPs in the same year.

QTPs were created by the Small Business Job Protection Act of 1996 and are governed by IRC Sec. 529. A QTP (often called a “529 plan”) is a program that allows individuals to prepay or to contribute to an account established for paying a student’s qualified education expenses. QTPs are established and maintained by state governments (or agencies of a state) or by eligible educational institutions. The program must meet certain requirements. Information about these programs can be obtained from the sponsoring state government or educational institution.

ESAs have been overshadowed by QTPs primarily because the amount of money that can be set aside in QTPs for the benefit of a student is much greater than that for ESAs. The contribution limit for QTPs is set by state laws, and most states allow for a maximum account value ranging from $235,000 to $529,000. Since the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), $2,000 per year may be contributed to ESAs for a child. Before 2018, individuals could take 529 plan distributions to only pay for qualified post-secondary education expenses. But effective for distributions taken after December 31, 2017, the Tax Cuts and Jobs Act of 2017 allows 529 plan assets of up to $10,000 per child annually to be used to pay for elementary and secondary school tuition expenses.

Most financial organizations find ESA administration relatively simple because ESAs are administered in a similar manner as other savings vehicles they offer, like individual retirement arrangements (IRAs).

NOTE: While a full discussion of QTPs is beyond the scope of this manual, some of the ESA rules cross paths with QTPs and are discussed where applicable in this manual.

Introduction to Coverdell ESAs • 1

https://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleA-chap1-subchapF-partVIII-sec530.htm



ESA Origins ESAs became available January 1, 1998, as a result of TRA-97 and at that time were called “Education IRAs.” In 2001, the Education IRA was renamed the Coverdell education savings account (ESA) in honor of the late Senator Paul Coverdell (R-Georgia), a long-time champion of education savings. The enactment of the EGTRRA brought about many improvements to ESAs, making them more attractive to taxpayers and providing an additional business opportunity for financial organizations. EGTRRA was enacted with a sunset provision that made its provisions temporary, but the American Taxpayer Relief Act of 2012 made the ESA provisions permanent.

General RequirementsAn ESA is just that—a savings arrangement in which contributions are invested for the purpose of funding a child’s education. The total contributions for a child (referred to as the “designated beneficiary” of an ESA) cannot be more than $2,000 per year no matter how many ESAs have been established for the child or how many people are contributing on behalf of the child. Anyone under certain income levels—grandparents, parents, other family members, friends, and even the child—may contribute on behalf of a child, but most often the parents and grandparents make the ESA contributions.

Contributions can be made to ESAs up to a child’s 18th birthday. Contributions are not tax deductible by the contributor and go into the ESA as after-tax assets (basis), but the interest earned is tax-free if used for qualified education expenses. Once the designated beneficiary turns age 30, the entire balance in the ESA must be distributed within 30 days unless the beneficiary is of special needs. One way for the beneficiary to avoid paying taxes, however, is to transfer the balance to an ESA of a qualified family member.

ESA Advantages There are several primary benefits for saving for education with ESAs.

• Savings in an ESA can start early, allowing for many years to build interest.

• Anyone within certain income restrictions can fund an ESA for a child.

• A responsible individual (usually the parent or legal guardian) makes the investment and distribution decisions.

• ESA savings can be used for elementary and secondary education, as well as for higher education.

• Distributions are tax-free if used to for education. If not used for education, only the earnings are subject to federal income tax.

• ESA assets can be transferred to an ESA for a qualified family member.

The advantage of tax-free growth cannot be overstated. In an ESA, the untaxed earnings boost the compounding effect. Following is a simple example showing the value comparison of saving with a tax-favored ESA versus a taxable savings vehicle.

2 • Introduction to Coverdell ESAs

Government Resources for ESAs

ESA compliance is based on directives by several sources, including the Internal Revenue Code, Treasury regulations, IRS pronouncements, and other governmental guidance. Compliance often depends on timely access to information. Legislation and IRS guidance may be released quickly with little advance warning. Therefore, financial organizations should ensure their access to necessary information by using information sources or consulting services, attending education courses, and working closely with the organization’s advisors. In audit situations, the IRS does not view insufficient resources as a valid excuse for noncompliance.


Growth Potential Comparison With $2,000 Annual Contributions(assumes 4% interest and marginal tax rate of 25%)

Coverdell ESA Taxable Savings Account

Year Balance Balance

1 $ 2,000.00 $ 2,000.00

2 $ 4,080.00 $ 4,060.00

3 $ 6,243.20 $ 6,181.80

4 $ 8,492.93 $ 8,367.25

5 $10,832.65 $10,618.27

6 $13,265.95 $12,936.82

7 $15,796.59 $15,324.92

8 $18,428.45 $17,784.67

9 $21,165.59 $20,318.21

10 $24,012.21 $22,927.76

11 $26,972.70 $25,615.59

12 $30,051.61 $28,384.06

13 $33,253.68 $31,235.58

14 $36,583.82 $34,172.65

15 $40,047.18 $37,197.83

16 $43,649.06 $40,313.76

17 $47,395.02 $43,523.18

18 $51,290.83 $46,828.87

A limited number of resources define the basic ESA rules, but other guidance and regulations (like some for QTPs and IRAs) also come into play for ESA administration. These are the primary government resources for ESAs.

• IRC Sec. 530, Coverdell Education Savings Accounts

• Notice 97-57, Nonbank Trustees and Custodians for Education IRAs

• Notice 97-60 on education tax incentives (Certain items are now obsolete.)

• Notice 2003-53 on reporting requirements

• Form 5305-E, Coverdell Education Savings Trust Account

• Form 5305-EA, Coverdell Education Savings Custodial Account

• Form 5498-ESA, Coverdell ESA Contribution Information, and instructions

• Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530), and instructions

• IRS Publication 970, Tax Benefits for Education

Internal Revenue CodeThe Internal Revenue Code (IRC) is created by Congress and is a compilation of tax laws. ESAs are governed by IRC Sec. 530, but some of the rules are described in miscellaneous IRC sections, including IRC Sec. 529, Qualified Tuition Programs.

Treasury RegulationsThe IRS is the government agency that is responsible for writing Treasury regulations (Treas. Regs.) that interpret and implement the Internal Revenue Code. The IRS has not yet released regulations under IRC Sec. 530 for ESAs, but miscellaneous other regulations under other sections of the Code come into play with ESAs. These are described where applicable in this manual.

Revenue ProceduresA revenue procedure (Rev. Proc.) outlines specific procedures necessary to comply with IRS rules and regulations.

Revenue RulingsThe IRS releases revenue rulings as an interpretation of laws and Treasury regulations as applied to a specific set of facts. Revenue rulings may be relied upon as the IRS’ official position on the specific set of facts. But the IRS reserves the right to restate any position by modifying or replacing a previously published ruling.

IRS Announcements and NoticesIRS announcements and notices are published when taxpayers need immediate information on specific issues. The language in announcements and notices may appear later in revenue rulings or revenue procedures generated to explain the topic in more detail. Taxpayers can rely on the information supplied in announcements and notices.



https://www.irs.gov/pub/irs-drop/n-03-53.pdf

https://www.irs.gov/pub/irs-pdf/f5305e.pdf

https://www.irs.gov/pub/irs-pdf/f5305ea.pdf

https://www.irs.gov/pub/irs-prior/f5498e--2021.pdf

https://www.irs.gov/pub/irs-pdf/f1099q.pdf

https://www.irs.gov/pub/irs-pdf/p970.pdf





IRS PublicationsThe IRS releases publications designed to explain a variety of tax topics using layman’s terms. IRS Publication 970, Tax Benefits for Education, updated annually, is a publication for taxpayers that contains ESA information. Copies of IRS publications may be obtained free of charge from the IRS website.

IRS FormsThe IRS publishes many information returns and accompanying instructions every year. Financial organizations are required to file certain IRS information returns each year to report ESA transactions, and designated beneficiaries (or guardians on their behalf) may be required to file certain tax forms as well. Often, the instructions to these forms contain information on certain rules or procedures that are not available from any other source.

Private Letter RulingsPrivate letter rulings (PLRs) are opinions written by the IRS in response to a written request from a taxpayer regarding a specific set of facts. They may be relied upon only by the taxpayer who applied for the ruling. But a PLR gives some indication to all taxpayers about how the IRS views a particular issue. Guidance on the fees associated with applying for PLRs and the procedures are found in IRS revenue procedure (Rev. Proc. 2021-4).

Organizations That May Offer ESAs

A trustee or custodian of an ESA must be a bank as defined in IRC Sec. 408(n) or another organization that has acquired nonbank trust powers from the Treasury Department (IRC Sec. 530(b)(1)(B)). The bank definition under IRC Sec. 408(n)(2) includes insured credit unions within the meaning of paragraph (6) or (7) of Sec. 101 of the Federal Credit Union Act. IRS Notice 97-57 indicates that financial organizations approved as nonbank trustees and custodians for Traditional IRAs (e.g., brokerage firm, insurance company, trust company) may automatically offer ESAs. (For reference purposes, the term “financial organization” will be used to identify all entities that offer ESAs.)

A person or entity may apply for nonbank trustee powers by filing a request for approval in accordance with the procedures established in Treas. Reg. 1.408-2(e)(1)-(5) and Rev. Proc. 2021-4. In addition to the application, the revenue procedure imposes an IRS user fee of $10,000 for anyone applying for approval to become a nonbank trustee.

Parties Involved With ESAs

With Traditional IRAs, the active parties generally involved are the IRA owner who establishes and contributes to the Traditional IRA and the financial organization that maintains the IRA on behalf of the IRA owner. But with ESAs, there may be numerous parties who play an active role in the establishment and maintenance of an ESA. Each party has specific roles and responsibilities with ESAs, and some of these responsibilities are described in the ESA plan agreement (See Chapter 2, Opening an ESA).

The parties involved with ESAs are the financial organization (trustee or custodian), grantor or depositor, designated beneficiary, responsible individual, contributor, and death beneficiary.




https://www.irs.gov/irb/2021-01_IRB#REV-PROC-2021-4

https://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleA-chap1-subchapD-partI-subpartA-sec408.htm


https://www.irs.gov/irb/2021-01_IRB#REV-PROC-2021-4

Financial OrganizationServing as the trustee, custodian, or issuer for the ESA, the financial organization is in charge of administering the ESA on behalf of the designated beneficiary. The financial organization must follow certain compliance requirements as defined in the law and by the IRS. These requirements are explained in detail throughout this manual.

Designated BeneficiaryThe designated beneficiary generally is an individual under the age of 18 on whose behalf an ESA is established. The purpose of an ESA is to help provide for the designated beneficiary’s qualified education expenses. Upon the age of 30, any assets remaining in the ESA must be distributed to the designated beneficiary, or the ESA may be transferred to an ESA for a qualifying family member as defined in IRC Sec. 529(e)(2).

The age 18 and 30 restrictions are waived for designated beneficiaries identified as having special needs (IRC Sec. 530(b)(1)). “Special needs” is not yet defined in official IRS guidance, but the Conference Agreement notes for EGTRRA indicate the intent of Congress is to include individuals who require additional time to complete their education because of physical, mental, or emotional conditions (including learning disabilities).

Grantor/DepositorThe grantor/depositor is the person who establishes the ESA with the financial organization for the benefit of the designated beneficiary. Note that the IRS uses the term “grantor” for purposes of trustee documents, and the term “depositor” for custodial documents. In most cases, the grantor/depositor is a parent, grandparent, or other close family member, but there is no requirement that the grantor/depositor bear any relationship to the designated beneficiary of the ESA. The grantor/depositor generally names the responsible individual for the ESA.

Responsible IndividualThe responsible individual usually is a parent or legal guardian of the designated beneficiary. If the ESA document permits, someone other than the designated beneficiary’s parent or legal guardian may serve as the responsible individual. Depending on elections made when the ESA is established, the designated beneficiary could become the responsible individual upon the age of majority set by state law.

Unless the ESA is a managed ESA (i.e., the financial organization manages the investments), the responsible individual has exclusive rights to direct the ESA investments. The responsible individual must direct the financial organization regarding all ESA transactions, including contributions, transfers and rollovers, distributions, and designation of death beneficiaries.

ContributorWhile parents, grandparents, and other close family members most often are the primary contributors to ESAs, there is no requirement that a contributor be related to the designated beneficiary of the ESA. In fact, EGTRRA clarified that an entity (e.g., a business, organization, etc.) may contribute to an ESA. The grantor/depositor is the initial contributor to the ESA at the point of establishment, but the financial organization maintaining the ESA thereafter may accept contributions from any other individual or entity as a contributor. Even the designated beneficiary of the ESA may fund the ESA.




Family MemberAn ESA may be transferred or rolled over to an ESA of a qualifying family member as defined in IRC Sec. 529(e)(2). The family member must qualify as a designated beneficiary. Qualified family members include

• the spouse;

• the son, daughter, stepchild, eligible foster child, adopted child, or descendant of child;

• a brother, sister, stepbrother, or stepsister;

• the father, mother, stepfather, or stepmother;

• an uncle or aunt;

• a niece or nephew;

• a son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law;

• the spouse of any individual describe above; and

• a first cousin.

Death BeneficiaryA death beneficiary is the individual or entity intended to receive the ESA assets upon the designated beneficiary’s death. Financial organizations must distribute ESA assets to the death beneficiary within 30 days after the designated beneficiary’s death. But a death beneficiary who is a qualified family member under the age of 30 becomes the designated beneficiary as of the date of death. If a qualified family member becomes the designated beneficiary, such designated beneficiary’s parent or legal guardian becomes the new responsible individual.

ESA Penalties

Financial organizations offering ESAs generally are concerned about compliance for two primary reasons: to avoid IRS penalties assessed for noncompliance and to avoid jeopardizing the tax benefits available to ESA designated beneficiaries. Avoiding IRS penalties is not difficult if financial organization personnel make a serious effort to learn, to stay current with, and to adhere to the government’s strict requirements. Seminars, technical reference books, professional publications, checklists, and internal compliance reviews all help to maintain a trouble-free ESA program.

Financial Organization PenaltiesFinancial organizations generally may be fined for noncompliance in two areas: ESA opening documents and ESA reporting. Following is a summary of the financial organization’s requirements, authority, and applicable penalties for noncompliance.



Designated Beneficiary PenaltiesMany financial organizations are concerned with compliance issues that are ultimately the designated beneficiary’s responsibility. Although the designated beneficiary may be faced with the associated penalties, responsible individuals often bring these questions to the financial organization. While financial organizations should refer individuals to their tax advisors for questions about their specific situations, a general knowledge of the penalties may prove helpful. A summary of designated beneficiary penalties follows.


ESA Financial Organization Penalties

OPENING DOCUMENTS PENALTY CODE SECTION

Failure to furnish a copy of the plan agreement (e.g., Form 5305-E or 5305-EA) to the grantor/depositor (and any other required party)

$50 for each failure IRC Sec. 6693(a)

Failure to furnish responsible individual (and any other required party) with a copy of an amendment to the plan agreement when such an amendment is required by the tax laws or regulations

$50 for each failure IRC Sec. 6693(a)

NOTE: While there has been no specific guidance that the reporting penalties of IRC Sec.6693(a) apply to the plan agreement, the same requirements and penalties that apply to Traditional IRAs under IRC Sec. 6693(a) likely apply to ESAs.

REPORTING PENALTY CODE SECTION

Failure to timely file Form 5498-ESA with the IRS

$50 for each failure, no maximum

IRC Sec. 6693(a); 530(h)

Failure to timely file Form 5498-ESA with the designated beneficiary


IRC Sec. 6693(a); 530(h)

Failure to timely file Form 1099-Q with the IRS


IRC Sec. 6693(a); 530(h)

Failure to provide Form 1099-Q to the designated beneficiary


IRC Sec. 6693(a); 530(h)

https://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleF-chap68-subchapB-partI-sec6693.htm










Responsibilities

All the parties involved with ESAs have certain roles and responsibilities for the ESA. Following is a basic summary of the responsibilities, all of which are discussed in detail later.

Financial Organization ResponsibilitiesThe financial organization acting as the ESA trustee or custodian has five essential areas for which it is responsible: plan establishment, document amendments, contributions, distributions, and reporting. Note that while financial organizations that administer IRAs must apply income tax withholding on IRA distributions, withholding is not required for ESAs.

Plan EstablishmentFinancial organizations must provide certain ESA documents to establish an ESA, and copies must be provided to involved parties. An ESA application should be completed by the grantor/depositor who is opening the ESA. A copy of the ESA plan agreement and the disclosure statement, if applicable, must be provided to the grantor/depositor (and the responsible individual if required by the plan agreement). The financial organization also must apply its Customer Identification Program (CIP) requirements when ESAs are established. (See Chapter 2, Opening an ESA.)

A financial organization must retain a copy of the ESA plan agreement that is signed by the grantor/depositor and if the document requires, also signed by the responsible individual. Alternatively, a written statement from the grantor/depositor acknowledging receipt of the document may be obtained and retained.


ESA Designated Beneficiary Penalties

DEFICIENCY PENALTY REFERENCE

Distributions not used for qualified education expenses: any distribution from an ESA that is included in gross income, such as a nonqualified distribution of earnings or the net income attributable to an excess contribution removed before the tax filing deadline plus extensions (certain exceptions apply)

10% penalty tax IRC Sec. 530(d)(4)(A)

Excess contribution: contributions made to an ESA on behalf of a designated beneficiary that exceed the contribution limit or when the contributor’s MAGI exceeds the applicable limits and the contributions are not removed with attributable earnings before the designated deadline (see Chapter 3, ESA Contributions)

6% penalty tax IRC Sec. 4973


https://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleD-chap43-sec4973.htm

AmendmentsFinancial organizations may need to amend ESA plan agreements from time to time to comply with law changes and for other business reasons. Although ESAs do not require disclosure statements, if an organization elects to use one, disclosure statements also should be amended when needed. Document providers, like Ascensus, often assist and lead the process when amendments become necessary. Financial organizations should retain copies of all amendments.

ContributionsFinancial organizations should document the receipt of ESA contributions. A contribution form generally is used and retained in the designated beneficiary’s file. This will prove helpful to verify the accuracy of contribution reporting.

DistributionsFinancial organizations must follow the responsible individual’s instructions for distributions and should document ESA distributions. ESA distribution or withdrawal forms should be retained in the designated beneficiary’s file and used as a resource to verify proper reporting of the distributions. Financial organizations are not responsible for determining whether the withdrawn assets are used for qualified education expenses.

ReportingFinancial organizations report ESA contributions on Form 5498-ESA, Coverdell ESA Contribution Information, and ESA distributions on Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530). The designated beneficiary and the responsible individual (if required by the plan agreement) must be provided with copies of all required IRS information returns. If reporting errors occur, the financial organization must submit corrected forms to the IRS and the designated beneficiary (and the responsible individual, if applicable) as needed.

Grantor/Depositor ResponsibilitiesThe grantor/depositor generally performs the following duties. Most of these details are documented on the ESA application that the grantor/depositor completes to establish the ESA.

• Establish the ESA with the financial organization for the benefit of the designated beneficiary.

• Identify the responsible individual.

• Deposit the initial contribution to the ESA.

• Instruct the financial organization on how to invest the initial contribution.

• Provide the financial organization with the information necessary to prepare required reports.

Responsible Individual ResponsibilitiesThe responsible individual generally performs the following duties.

• Receive a copy of the plan agreement and disclosure statement.

• Instruct the financial organization on how to invest contributions, including redirecting the investment of the initial contribution if desired.

• Direct the financial organization regarding the administration, management, and distribution of the account, unless the plan agreement indicates otherwise.




• Receive copies of ESA reports from the financial organization if required by the plan agreement.

• Name a successor responsible individual if the need arises.

• Name or change the death beneficiary if needed.

• Notify the financial organization of any address changes for the individuals identified on the plan agreement.

• Remove any excess contributions made to the ESA.

Plan agreement permitting, the responsible individual may change the designated beneficiary of the account to another member of the designated beneficiary’s family.

Designated Beneficiary ResponsibilitiesThe designated beneficiary (and/or the legal guardian) generally performs the following duties.

• Assume the role of responsible individual for the ESA upon attainment of the age of majority under state law if directed to do so on the ESA application or plan agreement.

• Receive required ESA reports from the financial organization.

• If amounts distributed from the ESA are not used for qualified education expenses, include a portion of the distribution in taxable income for the year and pay a 10 percent penalty tax on the taxable amount, if applicable.

• Complete and file income tax returns with the IRS that reflect ESA distributions.

Contributor ResponsibilitiesThe contributor generally performs the following duties.

• Determine eligibility to contribute to the ESA.

• Determine the maximum contribution amount based on the contributor’s modified adjusted gross income.

Death Beneficiary ResponsibilitiesThe death beneficiary (and/or the legal guardian) generally performs the following duties.

• Receive the ESA assets upon the designated beneficiary’s death within 30 days after the date of death, if applicable.

• Assume the position of designated beneficiary if death beneficiary is a qualified family member under the age of 30 (IRC Sec. 530(d)(7)).

• Assume the responsibilities of the responsible individual if past age of majority at the time of the designated beneficiary’s death.



Summary of Roles and ResponsibilitiesThe following table may be helpful in sorting through the roles and responsibilities of the various parties involved in ESAs.


Financial Organization

Grantor/ Depositor

Responsible Individual

Designated Beneficiary Contributor

Establish ESA X X

Name Designated Beneficiary

X

Contribute to ESAX

*must be eligible

X*must be eligible

X*must be eligible

X*must be eligible

Name Responsible Individual

X

Name Successor Responsible Individual

X X

Name New Designated Beneficiary

X

X*if becomes responsible individual

Name Death Beneficiary

X X


Receive Required Reporting

X*if required by the plan agreement

X

Receive Amendments

X*if required by the plan agreement

X


Direct ESA InvestmentsX

*initial investment

X


Send Reporting to IRS and Designated Beneficiary

X


Financial Organization

Grantor/ Depositor

Responsible Individual

Designated Beneficiary Contributor

Request ESA Distributions

X


Maintain ESA (e.g., amend documents, process transactions)

X

Remove ESA Excess Contributions

X*upon

direction from responsible individual

X


Chapter 2

Opening an ESAOpening Documents

Plan Agreement

Disclosure Statement

Document Amendments

Identifying Involved Parties

Customer Identification Program

Contribution Information

Certificate of Eligibility

Investment Selection

Compliance Check

Opening Documents

Coverdell ESA compliance begins the moment an ESA is established. To ensure compliance, financial organizations must provide certain documents to individuals who open ESAs. An ESA must be established using a written governing instrument that specifically designates the account as an ESA (IRC Sec. 530(b)(1)).

A plan agreement is the only document required to establish an ESA. The financial organization must provide a copy of the plan agreement to the grantor/depositor (the person who opens the ESA) upon establishment. Unlike IRAs, there is no requirement that a disclosure statement or financial disclosure be provided for ESAs. Ascensus, however, recommends that financial organizations provide a disclosure statement to the grantor/depositor as a display of good customer service. A copy may also be provided to the responsible individual, who has control over the ESA after it is established.

Plan Agreement

The IRS requires that an ESA document be signed by the ESA administrator (a financial organization representative) and the grantor/depositor to establish an ESA. Financial organizations may

• use the IRS ESA model document Form 5305-E, Coverdell Education Savings Trust Account, or Form 5305-EA, Coverdell Education Savings Custodial Account,

Opening an ESA • 15




• use a standardized document kit (application, plan agreement, and disclosure statement) from a forms provider; or

• draft a custom-designed document.

Forms providers, like Ascensus, provide ESA plan documents that generally are based off of IRS model plan agreements, but also include disclosure statements and other information. Such forms providers amend the ESA documents as necessary and timely facilitate these amendments with their clients. The most current versions of the IRS model documents—Forms 5305-E and 5305-EA—carry a revision date of October 2016. Insurance companies (with nonbank trust powers) may use the government model ESA forms or forms provider documents to establish ESAs.

While the ESA model plan agreements do not indicate that copies of the documents must be provided to the responsible individual, Ascensus recommends providing copies of the plan agreement (and disclosure statement if applicable) to both the grantor/depositor and the responsible individual. The responsible individual is responsible for the ESA, and therefore has a need for the information. Note, however, that the grantor/depositor often is the responsible individual named on the ESA document.

No Prototype Program For some types of arrangements (e.g., IRAs), an attorney generally drafts a prototype document according to specific IRS guidelines and submits the prototype document to the IRS for approval. A prototype often includes provisions giving more flexibility than the IRS model forms. As of this writing, the IRS had not opened a prototype program for ESA documents.

Proof of Plan Agreement ReceiptTo prove that the plan agreement was received, an ESA grantor/depositor should sign and date a copy of the plan agreement or an acknowledgment that he received a copy of the plan agreement. Often the acknowledgment is found as part of the signature section on the ESA application. The financial organization should retain the signed copy or acknowledgment in the designated beneficiary’s file or its electronic storage system, if applicable, as the required proof.

NOTE: Some ESA plan agreements also may require the responsible individual’s signature to acknowledge receipt of the plan agreement. IRS Forms 5305-E and 5305-EA require only the grantor’s/depositor’s signature.

Contents of the Plan AgreementEvery professional who works with ESAs should be familiar with the contents of the ESA plan agreement. The plan agreement lists the responsibilities of the grantor/depositor, responsible individual, contributor, designated beneficiary, and financial organization serving as trustee or custodian. Because there is no prototype program for ESAs, forms providers generally design plan agreements for their ESA document kits based on the IRS model forms. A summary of the general provisions found in IRS Forms 5305-E and 5305-EA follows.

Article IThe financial organization may accept contributions in cash until the designated beneficiary reaches age 18. Contributors are subject to certain modified adjusted gross income (MAGI) eligibility criteria. The deadline for contributions is the designated beneficiary’s tax return due date (not including extensions).

16 • Opening an ESA





Article II ESA assets may not be invested in life insurance contracts and may not be commingled with any other property except in a common trust fund or a common investment fund.

Article III The ESA balance must be distributed to the designated beneficiary within 30 days after he attains age 30. Any balance must be distributed within 30 days after the designated beneficiary’s death unless the death beneficiary is a qualified family member under the age of 30.

Article IV The grantor/depositor will direct the financial organization regarding the investment of the contributions, but the responsible individual has the power to change the investment instrument and to direct investments for future contributions. The responsible individual also will direct the financial organization regarding the administration, management, and distributions.

Article V The responsible individual will be the designated beneficiary’s parent or guardian. There shall be only one responsible individual at a time. A named successor may become the responsible individual upon the responsible individual’s death if the designated beneficiary is a minor. The grantor/depositor may elect whether the designated beneficiary becomes the responsible individual upon reaching the age of majority.

Article VI The grantor/depositor may elect whether the responsible individual may change the designated beneficiary under this agreement to a qualified family member.

Article VII The financial organization agrees to provide required reports to the IRS and to the responsible individual, and the grantor/depositor agrees to provide the financial organization with any necessary information to complete the reports.

Article VIII Articles I through III of the plan agreement are controlling.

Article IX The plan agreement may be amended for law changes and for published IRS guidance as needed.

Article XArticle X is left blank to allow the financial organization to add any provisions that comply with state law and the Internal Revenue Code.



Before the release of the March 2002 versions of IRS model ESA plan agreements, Forms 5305-E and 5305-EA indicated that financial organizations had to provide a disclosure statement (a document that contains a nontechnical explanation of the ESA rules) to the grantor/depositor and to the responsible individual of an ESA. The plan agreements also indicated that Notice 97-60 could serve as a sufficient disclosure statement. This information, however, was removed from the March 2002 versions of these forms. When questioned about this change, an IRS attorney commented to Ascensus that disclosure statements are not required for ESAs and acknowledged that some of the information in Notice 97-60 was obsolete. There is no other IRS guidance that addresses ESA disclosure statements.

To provide good service, however, Ascensus recommends that financial organizations provide disclosure statements along with plan agreements to the grantor/depositor and to the responsible individual. Financial organizations generally may provide as a disclosure statement a copy of IRS Publication 970, Tax Benefits for Education, or a disclosure statement from a forms provider.

Document Amendments

The ESA plan agreement incorporates ESA rules and regulations mandated by Congress or through IRS pronouncements. Unlike IRAs, which have specific rules on the manner and timing of amendments (Treas. Reg. 1.408-6(a)(4)(ii)(C)), there is no written guidance requiring organizations to amend ESA documents for law changes. But financial organizations find it helpful to amend to the latest ESA plan documents whenever possible. This practice keeps clients informed of the latest rules affecting ESAs, many of which are beneficial to both the client and the financial organization.

When amending ESA documents, financial organizations should follow these procedures.

1. Obtain the appropriately updated ESA plan agreement (e.g., Form 5305-E, Form 5305-EA, or an ESA plan agreement from a forms provider) and disclosure statement, if applicable.

2. Provide amendments to the responsible individual. The language in the ESA document or the financial organization business procedures may require amendments to also be provided to the designated beneficiary or the grantor/depositor.

3. Place a copy of each amendment in the designated beneficiaries’ files or retain a single copy of the amendment and accompanying cover letter in a master file with a list of each ESA designated beneficiary whose ESA was amended and the names of each responsible individual to whom the amendment was sent.

Identifying Involved Parties

The grantor/depositor should provide the names and information of the parties involved in the ESA on the Coverdell ESA application or plan agreement (see Chapter 1, Introduction to Coverdell ESAs, for descriptions of the parties involved with ESAs). After an ESA is established, however, the responsible individual may change the parties involved with the ESA (e.g., name a new responsible individual or a death beneficiary). These changes should be documented with the responsible individual’s signature and the date. Financial organization personnel should be sure to look to the most current documents in the designated beneficiary’s file to determine who the applicable parties are for the ESA.





http://www.ecfr.gov/cgi-bin/retrieveECFR?gp=&SID=2994ed0031727622ae97f0a6b7fb5c0d&mc=true&r=SECTION&n=se26.6.1_1408_66



Grantor/DepositorThe grantor/depositor is the person who establishes the ESA with the approved financial organization for the benefit of the designated beneficiary, and is usually the first contributor. The name of the grantor/depositor must be listed on the ESA plan agreement along with the grantor’s/depositor’s identifying information.

Designated BeneficiaryThe designated beneficiary is the individual on whose behalf the ESA is established. The grantor/depositor identifies the designated beneficiary on the plan agreement or application upon establishment of the account. An ESA may be established with contributions for a designated beneficiary who has not turned age 18. A new ESA may be established through a transfer or rollover for a designated beneficiary under the age of 30.

If the grantor/depositor elects on the plan agreement, the responsible individual of the ESA may change the designated beneficiary to a qualified family member of the designated beneficiary who is under the age of 30. Qualified family members of the designated beneficiary include the spouse, child, grandchild, sibling, parent, niece or nephew, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law, and the spouse of any such individual. A designated beneficiary’s first cousin (but not a cousin of his or her spouse) is also a qualified family member.

Responsible IndividualThe grantor/depositor names the responsible individual on the plan agreement at the time the ESA is opened. The responsible individual generally is the parent or guardian of the designated beneficiary of the ESA. Document permitting, the responsible individual may be someone other than a parent or guardian. Only one responsible individual may be named on the plan agreement at a time. Under certain circumstances, the original responsible individual named on the plan agreement may be changed.

Death of Responsible IndividualIf the responsible individual dies or becomes incapacitated while the designated beneficiary is still a minor, the successor responsible individual becomes the responsible individual. The successor responsible individual is a person named by either the grantor/depositor at the time the ESA is established or by the responsible individual at a later time. The successor responsible individual generally is the other parent or guardian unless the document permits the responsible individual to be someone other than a parent or guardian. If a successor is not named, the other parent or a successor guardian will be the responsible individual.

Designated Beneficiary as Responsible IndividualThe designated beneficiary of the ESA becomes the responsible individual when she attains the age of majority (as determined under state law) unless the grantor/depositor elects otherwise in the plan agreement. The plan agreement contains an optional election, which, if checked, maintains that the responsible individual indicated on the plan agreement will continue to be the parent or guardian, even after the designated beneficiary reaches the age of majority under state law, until all the assets are distributed from the ESA. But if the responsible individual dies or is incapacitated after the designated beneficiary reaches the age of majority, the designated beneficiary will become the responsible individual.


Death of Designated BeneficiaryIf a family member who is a named death beneficiary becomes the designated beneficiary upon the death of the original designated beneficiary, the parent or guardian of the beneficiary who inherits the ESA will become the responsible individual unless the document specifies otherwise. Financial organizations should take caution that when a change to a new beneficiary causes an automatic change in the responsible individual, the parties to whom organizations send required reports may change.

Death BeneficiariesOne or more primary or contingent death beneficiaries may be named to receive the ESA assets upon the designated beneficiary’s death. The IRS model ESA forms do not facilitate the naming of death beneficiaries. Financial organizations generally may name death beneficiaries on ESA applications or on beneficiary designation forms.

If the designated beneficiary dies and a death beneficiary is a qualified family member under the age of 30, the death beneficiary becomes the designated beneficiary. If a death beneficiary is not named, then upon the designated beneficiary’s death, the financial organization generally must distribute the account to the designated beneficiary’s estate within 30 days. The age 30 requirement is waived for death beneficiaries with special needs. (See Chapter 4, ESA Distributions, for details.)

Customer Identification Program

The Uniting and Strengthening America by Providing Appropriate Tools Required To Intercept and Obstruct Terrorism Act (USA PATRIOT Act) was signed into law in 2001. This law required financial organizations to implement a customer identification program (CIP) by October 1, 2003. Accounts to be included in the CIP are deposit accounts, transaction or asset accounts, credit accounts, or other extension of credit accounts. Financial organizations, therefore, should include ESAs in their CIP.

As a minimum under the CIP, financial organizations should

• obtain adequate identification information (e.g., name, address, date of birth, identification number) before opening an ESA,

• verify the client’s identity when opening an ESA,

• make and maintain a record of the information obtained under the financial organization’s CIP procedures, and

• provide adequate notice that the information being obtained is to verify the customer’s identity.

ESA administrators should examine their financial organization’s CIP procedures for more details.


Contribution Information

At the time the ESA is established, financial organizations must obtain contribution information. Many financial organizations choose to use a contribution form (or the application when a new ESA is established) to capture information about

• the type of contribution (rollover, transfer, annual),

• the contribution amount,

• the year for which the contribution is made, and

• the basis and earnings amounts when assets are rolled over or transferred into an ESA.

Most ESA contribution forms have a place for the contributor to sign, certifying that the deposit is an eligible ESA contribution and the contribution information provided may be relied upon by the financial organization and the responsible individual as accurate.

Certification of Eligibility

A financial organization may ask for proof or certification that the contributor (usually the grantor/depositor when an ESA is established) is eligible to contribute to an ESA and that the designated beneficiary is eligible to receive an ESA contribution, even though this is not an IRS requirement. For example, the financial organization may ask the grantor/depositor to complete an ESA contribution eligibility form that verifies that he is within the modified adjusted gross income limits to make contributions and that the designated beneficiary is under age 18. Requesting such documentation up front may help financial organizations reduce the risk and frustration of removing excess contributions later.

Investment Selection

When ESAs are established, the grantor/depositor will select an investment for the ESA contributions from the investment options offered by the financial organization. The responsible individual may redirect the investment and may select investments for future contributions.

Some financial organizations offer just one ESA investment, which typically takes the form of an interest earning checking account, savings account, or share account. Offering a single investment helps make administration of ESAs easier. But some financial organizations offer a variety of investments, which may include time deposits with specified maturities (e.g., certificates of deposit, share term certificates) and other investments. Other than life insurance contracts and certain collectibles (as described in Article V of the plan agreement), there generally is no other federal limitation on the types of investments that can be offered for ESAs.

Also, the Truth-in-Savings (T-I-S) Act imposes additional disclosure requirements on certain investments. If the investment selected for the ESA is covered by T-I-S, the financial organization must provide the appropriate disclosures.


Compliance Check

The “Coverdell ESA Opening Documents Log Sheet” is a tool financial organizations may use to help ensure that the compliance requirements for ESA opening documents have been met. The log sheet should be retained in the designated beneficiary’s file, and is designed to show record that any involved parties have received the required documents, the financial organization has the required signatures, and that the forms the financial organization requires to open ESAs have been completed.


Coverdell ESA Opening Documents Log Sheet

Organization name _______________________________________________________________________________

Designated beneficiary name _______________________________________________________________________

Date of birth _________________________ Social Security number _______________________________________

Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Grantor/depositor name ___________________________________________________________________________

Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Responsible individual name _______________________________________________________________________

Relationship to designated beneficiary _______________________________________________________________

Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Successor responsible individual name _______________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Plan Agreement/Application

Form used ______________________________________________________ Revision date______________

Organization requires: Form 5305-E

Form 5305-EA

Forms provider document

________________________________________________________________

________________________________________________________________

Signatures: Grantor/depositor Yes No

Responsible individual Yes No

Organization Yes No

Copy to grantor/depositor: Yes No

Explain: ____________________________________________________________

___________________________________________________________________


Copy to responsible individual: Yes No

Explain: ____________________________________________________________

___________________________________________________________________

Copy retained: Yes No

Explain: ____________________________________________________________

___________________________________________________________________

Copy to data processor: Yes No NA

Explain: ____________________________________________________________

___________________________________________________________________

The responsible individual may change the designated beneficiary. Yes No

The responsible individual will continue to serve as the responsible individual Yes Noafter the designated beneficiary attains the age of majority under state law.

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________



Organization requires: Yes No


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________


Contribution Eligibility



Signature: Yes No


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Contribution and Investment



Signature: Yes No


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________



Explain: ____________________________________________________________

___________________________________________________________________

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Death Beneficiary Designation



Signature: Yes No


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Signature

Employer signature ___________________________________________________ Date_________________


Chapter 3

ESA ContributionsRegular Contributions


Contribution Deadline

Regular Contribution Procedures

Transfers

Rollovers

Tracking Basis and Earnings

Compliance Check

Regular Contributions

Coverdell ESA contributions generally are made as regular contributions that are subject to certain annual limits as defined in IRC Sec. 530(b)(1). But ESAs also can be established and funded with transfers and rollovers. Anyone who falls within certain income restrictions can make ESA contributions on behalf of an eligible individual, but often it is a parent or grandparent who makes the ESA contributions. Contributors receive no tax breaks or deductions for ESA contributions, so contribution amounts represent after-tax assets (basis) in the ESA.

Contributors may be

• the designated beneficiary,

• another person, and

• an entity (e.g., business, charity).

Contribution LimitThe maximum annual contribution to all ESAs owned by a designated beneficiary is $2,000. Before the passage of the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), the contribution limit was $500. This regular contribution limit for each designated beneficiary does not include rollover contributions or transfers from other ESAs. Although there is an aggregate, annual contribution limit for a designated beneficiary, there is no limit to the number of ESAs that an individual may have.

ESA Contributions • 27


Because several individuals or entities may make ESA contributions for the same designated beneficiary, it is important that contributions be tracked so that the contribution limit is not exceeded. The responsible individual of the ESA manages the ESA on behalf of the designated beneficiary and receives copies of contribution reports. As a result, the responsible individual generally monitors the annual limit.

Contributions in CashESA contributions must be made in cash or a cash equivalent, such as a check or electronic transfer from a checking account (IRC Sec. 530(b)(1)(A)(i)). If a check for an ESA contribution is returned because of insufficient funds, the contribution may be treated as received on the date that the check is subsequently honored or when the contributor provides a replacement check.


Contribution eligibility for an ESA is determined based on criteria that apply to two individuals—the designated beneficiary and the contributor.

Designated Beneficiary EligibilityESAs may be funded for a child under age18 (IRC Sec. 530(b)(1)). As a result of EGTRRA, ESAs may be funded for individuals with special needs beyond age 18. While the IRS has not provided guidance defining “special needs” for ESA purposes, the Conference Agreement notes for EGTRRA indicate the intent of Congress is to include individuals who require additional time to complete their education because of physical, mental, or emotional conditions, including learning disabilities.

Before EGTRRA, a designated beneficiary generally was not eligible to receive an ESA contribution if in the same year any amount was contributed to a qualified tuition program (i.e., IRC Sec. 529 prepaid tuition programs or college savings plans). But since 2002, contributions may be made to both an ESA and a qualified tuition program in the same year on behalf of the same individual.

Contributor EligibilityAny individual can contribute to an ESA on behalf of a designated beneficiary, provided the individual satisfies certain income thresholds based on her modified adjusted gross income (MAGI). The IRS does not require that the individual funding the ESA have income, but the individual cannot contribute if her income exceeds a certain income threshold for her filing status. Entities (e.g., corporations, tax-exempt organizations) may contribute on behalf of a designated beneficiary, but the MAGI limits for ESA contributions apply only to persons and not to entities (IRC Sec. 530(c)(1)).

Contributor Income ESA contribution eligibility depends on the contributor’s MAGI and income tax filing status as defined in IRC Sec. 530(c). The amount that an individual is eligible to contribute per designated beneficiary may be reduced if the MAGI falls within certain income ranges.

Once a contributor determines his maximum contribution amount, he may contribute this amount to ESAs for any number of designated beneficiaries. MAGI for this purpose is defined as adjusted gross income (AGI) as shown on the income tax return of the contributor, modified by adding income from sources within Puerto Rico and American Samoa, as well as adding any foreign earned income exclusion and any foreign housing exclusion or deduction.

28 • ESA Contributions





Contributors should seek competent tax advice to determine their contribution eligibility. Information on contributor eligibility and a worksheet to determine the contribution limit is contained in IRS Publication 970, Tax Benefits for Education. Following are the MAGI amounts for ESA contribution eligibility. Unlike certain other tax-related limitations, these limitations are not subject to cost-of-living adjustments.

Phase-Out Range for Single FilersThe following formula may be used to determine the maximum contribution for an individual who files an income tax return as single with MAGI between $95,000 and $110,000.

$2,000 x ($110,000–MAGI)––––––––––––––––––––––––– = Maximum contribution $15,000

Phase-Out Range for Joint FilersThe following formula may be used to determine the maximum contribution for an individual who files a joint income tax return with MAGI between $190,000 and $220,000. Married couples who file a joint tax return can both make ESA contributions based on the formula. Note, however, that the maximum contribution that can be made for any one designated beneficiary is $2,000 per year.

$2,000 x ($220,000–MAGI)––––––––––––––––––––––––– = Maximum contribution $30,000

EXAMPLE: Roger files a joint income tax return with his wife Jane, and wishes to make ESA contributions for their granddaughter. Their combined MAGI is $210,000, which falls within the phase-out range for joint filers. Based on the formula, Roger may contribute $667 to their granddaughter’s ESA. Jane could also make a $667 contribution for the granddaughter for a total of $1,334 between the two.

$2,000 x ($220,000–$210,000)–––––––––––––––––––––––––––– = $667 $30,000


MAGI Limits for ESA Contribution Eligibility

Filing status May contribute $2,000

May make partial contribution May not contribute

Single filers $95,000 or less $95,000–$110,000 $110,000 or more

Joint filers $190,000 or less $190,000–$220,000 $220,000 or more


Contribution Deadline

The deadline for a contributor to make ESA contributions for a tax year is her tax filing deadline (generally April 15), not including extensions. The law does not address the deadline for an entity. When the tax filing deadline falls on a Saturday, Sunday, or holiday, the deadline is the next business day.

Contributions that are made between January 1 and the tax return due date and are designated for the previous tax year are called “prior-year contributions.” The restriction that ESA contributions cannot be made to an ESA after the designated beneficiary turns age 18 seems to conflict with the treatment of prior-year contributions when the designated beneficiary turns 18 before April 15. The law provides that prior-year contributions are deemed to have been made on the last day of the previous calendar year. According to IRS comments to Ascensus, the age 18 restriction prevails in this situation, and contributions cannot be made once a designated beneficiary turns age 18, even if the contribution is intended for the previous year.

ESA contributions that are received by mail after the contribution deadline generally are considered timely made if the envelope carries a postmark date of on or before the applicable deadline. Financial organizations that choose to accept these contributions should save or image the envelope bearing the postmark in the customer’s file and contact the responsible individual to verify the tax year to which the contribution relates if it is not clearly indicated.

Extensions for Military PersonnelWhen certain military operations are initiated, the President may issue executive orders designating the relative locations as combat zones or qualified hazardous duty areas. In addition, the secretary of defense may designate certain military actions as contingency operations. The law generally provides automatic tax benefits to members of the Armed Forces (and their spouses) serving in or in support of designated combat zones (IRC Sec. 7508), contingency operations, or hazardous duty areas. Military personnel serving in or in support of qualified hazardous duty areas are afforded the same benefits that members serving in combat zones receive. The tax benefits include, among other things, postponements for making ESA contributions, completing ESA rollovers, and correcting ESA excesses.

IRC Sec. 7508(a)(1) describes certain tax acts that may be postponed by military personnel. Information may also be found in Treas. Regs. 301.7508-1 and 301.7508A-1 and in Revenue Procedure 2007-56. IRS Publication 3, Armed Forces’ Tax Guide, provides tax information for military personnel and describes existing combat zone areas. Related information is available on the IRS website.

As indicated in IRS Publication 3, the extended deadline to complete related tax actions for members of the U.S. Armed Forces serving in a combat zone, qualified hazardous duty area, or contingency operation is

• 180 days after the last day the individual served in the area (or, if later, the last day of qualified hospitalization due to related injuries), plus

• the number of days that remained to complete the tax action for the applicable year when the individual entered the combat zone.


https://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleF-chap77-sec7508.htm

http://www.ecfr.gov/cgi-bin/text-idx?SID=9761ebc586186401fe19b22a0c4582b9&mc=true&node=se26.20.301_17508_61&rgn=div8

https://www.ecfr.gov/cgi-bin/text-idx?SID=9761ebc586186401fe19b22a0c4582b9&mc=true&node=se26.20.301_17508a_61&rgn=div8

https://www.irs.gov/irb/2007-34_IRB/ar13.html

http://www.irs.gov/pub/irs-pdf/p3.pdf

Extensions for Disaster Area VictimsWhen disaster areas are declared, the IRS issues guidance regarding tax acts that may be postponed, usually in the form of news releases or notices. The relief generally applies to residents of the identified areas, those whose businesses or records necessary to meet a deadline are located there, and to certain relief workers providing assistance following the disaster events. Individuals visiting a covered disaster area who were injured or killed as a result of the event are also entitled to relief.

In December 2019, the Taxpayer Certainty and Disaster Tax Relief Act of 2019 amended Internal Revenue Code (IRC) Sec. 7508A by requiring a new mandatory 60-day postponement period for certain tax-related acts following a federally declared disaster. To help clarify the new rule, the IRS issued final regulations in June 2021. The regulations 1) explain how the new mandatory 60-day postponement period is determined, and 2) clarify how the term “federally declared disaster” is defined under IRC Sec.165.

This relief is available to certain individuals affected by federally declared disasters that occur on or after December 21, 2019, including

• individuals who reside in the federally declared disaster area,

• individuals who are injured in the disaster area,

• individuals who are completing tax-related acts on behalf of those killed in the disaster area,

• individuals whose principal place of business is in the disaster area,

• relief workers who provide assistance to affected individuals in the disaster area, and

• individuals whose tax records are located in the disaster area.

The tax-related acts covered by this guidance (e.g., making ESA contributions) are generally defined in IRC Secs.7508 and 7508A, Revenue Procedure 2018-58, and in Treasury Regulations. When a disaster occurs, the IRS announces the available relief in news releases that describe the affected area and the length of the deadline postponement.

Regular Contribution Procedures

When a contribution is made to an ESA on behalf of a designated beneficiary, the designated beneficiary enjoys the benefit of tax-deferred earnings and tax-free distributions if the designated beneficiary uses the distributed amounts to pay for qualified education expenses (IRC Sec. 530(d)). To ensure that amounts contributed to an ESA represent eligible contributions that are entitled to special tax status, the grantor/depositor, contributor, responsible individual, and designated beneficiary are required to follow certain rules and regulations that govern ESA contributions. Financial organizations administering ESAs should follow correct operational procedures when accepting ESA contributions to provide good service to their clients and to ensure that they properly report contributions.

When presented with an ESA contribution, financial organizations are not responsible for determining whether the grantor/depositor or contributor is eligible to make a contribution, nor are financial organizations responsible for determining the eligibility of a designated beneficiary to receive an ESA contribution. But to avoid the future hassle of dealing with excess ESA contributions, many financial organizations discuss the eligibility requirements with contributors and responsible individuals. Often this information is addressed on the ESA contribution eligibility forms.


https://www.govinfo.gov/content/pkg/FR-2021-06-11/pdf/2021-12311.pdf

https://www.irs.gov/pub/irs-drop/rp-18-58.pdf


Contribution ProceduresFinancial organizations should capture certain information at the time contributions are made so that they may properly report these contributions on Form 5498-ESA, Coverdell ESA Contribution Information. The following procedures will help ensure compliance when accepting ESA regular contributions.

The grantor/depositor should choose an investment for the initial contribution to the ESA. The responsible individual may thereafter redirect the investment and provide investment instruction for all subsequent contributions. The investment should be registered as part of the ESA in the designated beneficiary’s name. For example, “ABC Financial Organization as Trustee for Brian Peterson’s ESA.” The ESA administrator should retain the original copy of the investment instrument and provide any required investment disclosures to the responsible individual.

1. The financial organization may require that the grantor/depositor or contributor (as applicable) complete a contribution eligibility form to determine eligibility for the contribution.

2. The financial organization may require that the grantor/depositor or contributor complete an ESA contribution form (e.g., the ESA application or a separate form) that requests the following information.

• Designated beneficiary’s identifying information

• Contributor’s identifying information

• Date of deposit

• Amount of contribution and tax year for which the contribution is made

• Type of contribution (i.e., regular)

• The responsible individual’s investment selection if not previously provided

• Contributor’s signature

3. The financial organization may wish to forward a copy of the contribution form to the responsible individual.

4. The financial organization should refer to the contribution form for information necessary to report contributions on Form 5498-ESA.

5. The financial organization should retain all documentation of telephone conversations, correspondence with the grantor/depositor, contributor, or responsible individual, as well as any other information regarding the deposit in the designated beneficiary’s file, either in paper form or electronically.

Transfers

Transfers may be made to other ESAs or qualified tuition programs on behalf of the designated beneficiary. The Internal Revenue Code states that individuals may conduct a transfer between ESAs only under special rules relating to the death or divorce of the designated beneficiary (IRC Sec. 530(d)(7)). But the Tax Relief Act of 1997 (TRA-97) Conference Committee reports indicate that Congress intended to allow tax- and penalty-free movement of assets between ESAs under other circumstances. Further, the instructions to IRS Form 5498-ESA and Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530), confirm that tax- and penalty-free transfers of assets are allowed between ESAs and from ESAs to qualified tuition programs (i.e., IRC Sec. 529 plans). In addition, ESA assets may be transferred to an ESA of a qualified family member.







Qualified Family MembersThe responsible individual may transfer (or roll over) ESA assets to another ESA of the same designated beneficiary or to an ESA for the benefit of a qualified family member of the designated beneficiary. The new designated beneficiary must be under the age of 30. The age 30 restriction may be waived for a special needs beneficiary. While the IRS has not provided guidance defining “special needs” for ESA purposes, the Conference Agreement notes for EGTRRA indicate the intent of Congress is to include individuals who require additional time to complete their education because of physical, mental, or emotional conditions, including learning disabilities.

Qualified family members of the designated beneficiary include the spouse, child, grandchild, sibling, parent, niece or nephew, son-in-law, daughter-in-law, father-in-law, mother-in-law, brother-in-law, or sister-in-law, and the spouse of any such individual. A designated beneficiary’s first cousin (but not a cousin of his or her spouse) is also a qualified family member.

ESA Transfers Reported to IRSUnlike transfers between IRAs, transfers between ESAs and to qualified tuition programs are reportable transactions. The instructions to IRS Forms 1099-Q and 5498-ESA indicate that financial organizations should report direct trustee-to-trustee transfers to the IRS. IRS representatives commented to Ascensus, however, that transfers to a qualified family member within the same financial organization are nonreportable.

The financial organization sending the reportable transfer should check Box 4, Trustee-to-trustee transfer, on Form 1099-Q to indicate that the distribution amount shown in Box 1, Gross distribution, was transferred. Notice 2003-53 provides that financial organizations may leave Box 4 of Form 1099-Q blank if they do not have records indicating whether an ESA distribution is a trustee-to-trustee transfer. When transferred to another ESA, the receiving financial organization must include the amount in Box 2, Rollover contributions, of IRS Form 5498-ESA.

Unlimited TransfersThere is no limit to the number of trustee-to-trustee ESA transfers that a responsible individual may conduct on behalf of a designated beneficiary.

Death of Designated BeneficiaryIf the surviving spouse of a deceased ESA designated beneficiary is the death beneficiary listed for the ESA, the surviving spouse beneficiary is treated as the ESA designated beneficiary (IRC Sec. 530(d)(7) and IRC Sec. 220(f)(8)(A)). A nonspouse death beneficiary who is a qualified family member can assume the ESA as his own following the death of the ESA designated beneficiary (IRC Sec. 530(d)(7)). Ownership of the ESA transfers to that of the qualified death beneficiaries.

DivorceESAs are subject to a property division according to the terms of the divorce decree or legal separation instrument (IRC Sec. 530(d)(7)). Often a transfer occurs in this situation (see Chapter 6, Miscellaneous Compliance, for more on divorce).

Transfer ProceduresFinancial organizations should capture certain information when transfers take place. The following procedures will help ensure compliance when accepting ESA transfers.






http://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleA-chap1-subchapB-partVII-sec220.htm

http://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleA-chap1-subchapB-partVII-sec220.htm


1. To initiate a transfer, the responsible individual could complete an ESA transfer request form and provide it to the distributing financial organization. The transfer request form, which usually is completed by the receiving financial organization, generally should

• indicate a dollar amount or percentage to be transferred,

• provide any necessary information on the financial organization receiving the transfer and how the check should be drafted (e.g., “ABC Bank as Trustee of John Jake’s ESA”), and

• be signed and dated by both the responsible individual and the receiving financial organization.

2. If a transfer request form is not available, the responsible individual could complete a withdrawal statement with the transferring financial organization and a contribution form with the receiving financial organization. These forms should be completed to indicate that a transfer is being requested.

3. The responsible individual may hand deliver the form to the receiving financial organization or may mail it.

4. If the designated beneficiary does not have an existing ESA at the receiving financial organization, an ESA should be established.

5. The transferring financial organization should process the transaction and the responsible individual should deliver the check to the receiving financial organization if the check is not sent directly.

6. The transferring financial organization should provide a statement of the earnings portion of the withdrawal (see “Basis and Earnings Statement” later).

7. The responsible individual must choose an investment for the transferred assets. The investment should be registered as part of the ESA in the designated beneficiary’s name, such as “ABC Financial Organization as Trustee for Brian Peterson’s ESA.” The ESA administrator should retain the original copy of the investment instrument and provide any required investment disclosures to the responsible individual.

8. Financial organizations should retain in the designated beneficiary’s files copies of all supporting documentation for the transfer. This may need to be referenced for reporting purposes.

Rollovers

ESA assets may be rolled over to ESAs and to qualified tuition programs (IRC Sec. 529 plans). Qualified tuition program assets, however, may not be rolled over to ESAs. According to provisions of the IRS model ESA documents, the responsible individual has the power to direct the administration, management, and distribution of the ESA, unless otherwise provided for in the document. Therefore, the responsible individual is the person to initiate or authorize a rollover contribution.

Who May Receive RolloversIndividuals generally may roll over ESA assets to another ESA of the same designated beneficiary or to another ESA of the designated beneficiary’s qualified family member who is under the age of 30 (IRC Sec. 530(d)(5)). The age 30 restriction may be waived for special needs individuals. (See “Qualified Family Members” earlier.)




Election to Change the Designated BeneficiaryThe IRS model ESA documents require the grantor/depositor to elect whether the responsible individual may change the designated beneficiary under the ESA to another qualified member of the designated beneficiary’s family. Although it was first thought that an election prohibiting the responsible individual from changing the designated beneficiary would also prevent the responsible individual from rolling over assets from one designated beneficiary to another, the IRS commented to Ascensus that restricting rollovers between qualified family members was not the IRS’ intent. Until specific IRS guidance is released, financial organizations should proceed cautiously when asked to complete a rollover between ESAs of qualified family members if the ESA document prohibits the responsible individual from changing the designated beneficiary.

Rollovers Must Be in CashRollovers must be in the form of cash (IRC Sec. 530(b)(1)(A)(i)). While IRA rollovers also may be made with in-kind assets (an investment instrument, such as stock certificates), there currently is no written guidance allowing in-kind rollovers for ESAs.

60-Day RuleESA rollovers must be completed within 60 days after the date of distribution (IRC Sec. 530(d)(5)). While the IRS may waive the 60-day limitation for IRA rollovers in cases of certain hardship (i.e., casualty, disaster, or other events beyond the reasonable control), an IRS official confirmed to Ascensus that the 60-day waiver does not apply to ESA rollovers.

ESA rollovers are one of the tax acts described in IRS guidance that may be postponed for certain members of the Armed Forces and people affected by federal disaster areas as authorized by IRC Secs. 7508 and 7508A, Treasury Regulation 301.7508A-1(c)(1), and Revenue Procedure 2007-56 (see “Extensions for Military Personnel” earlier).

Before completing a rollover to an ESA, the responsible individual should certify that not more than 60 days have passed since the day of receipt of the distribution. This may be obtained on an ESA contribution or ESA eligibility form.

One-Per-12-Month RuleA designated beneficiary is allowed to do only one ESA rollover per 12 months. This 12-month period begins the day after the individual receives the distribution to be rolled over (IRC Sec. 530(d)(5)).

The IRS changed its interpretation of the one-per-12-month rule for IRA rollovers effective January 1, 2015, to follow a U.S. tax court ruling in Bobrow v. Commissioner (Announcement 2014-15 and 2014-32). The court ruled that an IRA owner is limited to one rollover per 12-month period, regardless of the number of IRAs he has. An IRS official commented to Ascensus that the IRS is applying the same interpretation to ESA rollovers.

Rollovers From Other SourcesIndividuals may not roll over Traditional, Roth, or savings incentive match plan for employees of small employers (SIMPLE) IRA assets to an ESA. In addition, an individual may not roll over distributions from a qualified tuition program under IRC Sec. 529, a qualified retirement plan, or other employer-sponsored retirement plans to an ESA. But ESAs can be funded by other sources.









https://www.irs.gov/pub/irs-drop/a-14-32.pdf


Savings BondsThe instructions for Form 5498-ESA state that individuals may roll over certain U.S. savings bonds to ESAs, and these should be reported in Box 2, Rollover contributions. IRC Secs. 135(b)(1)(A)(ii) and (c)(2)(c) indicate that a qualifying individual may cash in qualified U.S. savings bonds (series EE bonds issued after 1989 or series I bonds) without having to include the interest from the bond distribution in income if the individual contributes the amount to an ESA in the same year. An IRS official confirmed to Ascensus that liquidated bonds can be shielded from tax consequences to the extent that their value is moved to an ESA. But IRC Sec. 530(d)(5), which defines an ESA rollover contribution, does not include rollovers from eligible savings bonds as eligible rollover contributions. Given the current lack of guidance, clients should consider seeking competent tax advice before proceeding with one of these transactions.

Military-Related Death PaymentsThe Heroes Earnings Assistance and Relief Tax (HEART) Act of 2008 provides a number of tax-related benefits to military servicemembers and their beneficiaries. Among these benefits is a provision allowing survivors who receive tax-free military death gratuity payments and beneficiaries who receive Servicemembers’ Group Life Insurance payments to contribute these amounts as rollovers to their Roth IRAs and Coverdell ESAs (IRC Sec. 530(d)(9)). The rollover must be completed before the end of the one-year period beginning on the date the individual receives the payment. These rollovers to ESAs are reported in Box 2 on Form 5498-ESA.

The following requirements generally apply.

• The amount rolled over is not subject to the annual contribution limits or contribution income restrictions.

• The amount may be rolled over to both a Roth IRA and an ESA, but in aggregate may not exceed the total gratuity and insurance payments received by the survivor.

• The 60-day and the one-per-12-month rollover rules do not apply.

• The amounts rolled over are treated as basis (nontaxable assets) in the Roth IRA and ESA. If a subsequent distribution is not a qualified education distribution from the ESA, the amount of the distribution attributed to the gratuity or insurance payments is nontaxable.

Reporting ESA RolloversESA rollovers are reported on Forms 1099-Q and 5498-ESA. The distribution is reported on Form 1099-Q. If the assets are rolled over within 60 days, the receiving financial organization must report the rollover contribution in Box 2 on Form 5498-ESA.

Rollover Procedures Financial organizations should capture certain information when rollover contributions are made. The following rollover procedures will help ensure compliance when accepting rollover contributions.

1. To determine if the assets are eligible for rollover, the receiving financial organization may request the responsible individual to complete an ESA contribution eligibility form that addresses the following eligibility concerns.

• The 60-day rule.

• The one-per-12-month rule.

• The designated beneficiary is under age 30 or is a special needs beneficiary.


https://www.irs.gov/pub/irs-prior/i5498e--2021.pdf






The responsible individual should sign and date the form. An authorized person acting on behalf of the financial organization should witness the signature.

2. The financial organization should require the responsible individual to complete an ESA contribution form that includes the following information. By signing the form, the responsible individual designates the contribution as a rollover contribution.

• Designated beneficiary identifying information

• Contributor’s identifying information

• Date of deposit

• Contribution amount

• Contribution type (rollover)

• Investment selection, if applicable

• Responsible individual’s signature

3. The financial organization should retain the basis and earnings statement if one is received (see “Basis and Earnings Statement” later).

4. The responsible individual must choose an investment for the assets rolled over to the ESA. The investment should be registered as part of the ESA in the designated beneficiary’s name, such as “ABC Financial Organization as Trustee for Brian Peterson’s ESA.” The ESA administrator should retain the original copy of the investment instrument and provide any required investment disclosures to the responsible individual.

5. Financial organizations should retain in the designated beneficiary’s files copies of all supporting documentation for the rollover.

Tracking Basis and Earnings

Regular contributions are basis, but amounts that are transferred and rolled over will include portions of both basis and earnings. There are two reasons why financial organizations should track the basis and earnings portions in the ESA. First, the instructions to Form 1099-Q indicate that financial organizations can report the earnings and basis portions of distributions in Boxes 2 and 3, and second, financial organizations distributing assets for rollover and transfer must provide certain statements of the earnings portion of the distribution. The IRS, however, gives some relief from these requirements.

Reporting ReliefNotice 2003-53 provides temporary relief for the requirement to report the basis and earnings portions of ESA distributions on Form 1099-Q. Following the release of Notice 2003-53, the IRS sought public comment for suggestions on how financial organizations might track basis and earnings, acknowledging that many financial organizations may not have the appropriate historical documentation to accurately do so. The IRS has not yet provided any further detail. Until further guidance is issued, financial organizations should establish procedures to track basis and earnings in ESAs.


https://www.irs.gov/pub/irs-pdf/i1099q.pdf



Basis and Earnings StatementThe instructions for Box 4, Trustee-to-trustee transfer, of Form 1099-Q state that in a transfer between qualified education programs (e.g., between two ESAs or to a qualified tuition program), the distributing financial organization must provide to the receiving financial organization or qualified tuition program with a statement including the earnings portion of the transferred amount. The deadline to provide the statement is within 30 days of the distribution or by January 10, whichever is earlier. This statement assists in the tracking of basis and earnings in the ESA or under the qualified tuition program, and allows for proper reporting of basis and earnings on Form 1099-Q.

An IRS official commented to Ascensus that when assets are transferred from trustee to trustee, the statement should be given to the receiving financial organization. Further, an individual that receives a distribution is entitled to be given a statement of basis and earnings, which she may pass on to the receiving financial organization when completing a rollover. Notice 2003-53 did not address relief for providing the basis/earnings statement for transfers and rollovers, but the IRS official told Ascensus that this same relief also applies to transfer and rollover statements until further notice.

Compliance Check

The following sample “Coverdell ESA Contribution Log Sheet” is a tool financial organizations may use to help track the contribution type that is made to the ESA. The sample “Coverdell ESA Investment Log Sheet” may be used to document the investment selections. Any log or other tracking sheets used by financial organizations should be kept with the designated beneficiary’s records.




Coverdell ESA Contribution Log Sheet



Date of birth_________________________ Social Security number _______________________________________

Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Contributor name ________________________________________________________________________________

Responsible individual name________________________________________________________________________

Address _________________________________________________________________________________________

________________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Contribution Type

REGULAR CONTRIBUTION Yes No NA

Date _________________ Amount of contribution _______________________

Transaction information: Contributor: Grantor/depositor

Responsible individual

Other (name, address, phone)

___________________________________________________

___________________________________________________

___________________________________________________

Eligibility form used: Yes No

Form used _____________________________ Revision date________________

Contribution form used __________________ Revision date________________

Signed/dated by contributor: Yes No

Explain: ____________________________________________________________


Explain: ____________________________________________________________

Copy to contributor: Yes No

Explain: ____________________________________________________________


Explain: ____________________________________________________________



Explain: ____________________________________________________________

ROLLOVER CONTRIBUTION Yes No NA

Date_________________ Amount of contribution _______________________




___________________________________________________

___________________________________________________

___________________________________________________





Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________

TRANSFER CONTRIBUTION Yes No NA





___________________________________________________

___________________________________________________

___________________________________________________





Explain: ____________________________________________________________


Explain: ____________________________________________________________



Explain: ____________________________________________________________


Explain: ____________________________________________________________

Signature

Employee signature ___________________________________________________ Date_________________


Coverdell ESA Investment Log Sheet




Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Initial Contribution Investment Selection

Contribution information: Date__________________ Amount of contribution _______________________

Contributor: Grantor/depositor



___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Investment selected by: Grantor/depositor


Investment selected: Investment description ________

___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Date selected _______________________

Form used: Form __________________________________ Revision date ________________


Contribution/investment form sent to responsible individual:

Yes Date sent ______________________

No Explain: ____________________________________________________

___________________________________________________________

Additional Contribution Investment Selection

Ongoing investment direction instructions from the responsible individual for additional contributions (if applicable)

________________________________________________________________________________________________

________________________________________________________________________________________________

________________________________________________________________________________________________

________________________________________________________________________________________________


Contributor: Responsible individual


___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Responsible individual contacted to make investment selection:

Yes Date contacted ______________________

No Explain: ____________________________________________________

___________________________________________________________

Investment selected: Investment description _______________________________________________

___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Date selected _______________________



Yes Date sent ______________________

No Explain: ____________________________________________________

___________________________________________________________


Chapter 4

ESA DistributionsTaxation of ESA Distributions

Qualified and Nonqualified Distributions

Correcting Excess Contributions

Terminating ESAs Upon Age 30

Death Beneficiary Distributions

Distribution Procedures

Compliance Check

Taxation of ESA Distributions

ESA designated beneficiaries do not pay income tax on withdrawals from ESAs as long as the amounts withdrawn are equal to or less than the designated beneficiary’s qualified education expenses incurred at an eligible education institution for the year (IRC Sec. 530(b)). If an ESA distribution is used to pay for qualified education expenses, the distribution is a qualified distribution. IRS Publication 970, Tax Benefits for Education, provides information on ESA distributions.

All ESAs established on behalf of the same designated beneficiary are treated as one when determining the part, if any, that is subject to income tax. Income taxes for ESA distributions are computed based on the designated beneficiary’s tax year (usually a calendar year), and not the school year. For nonqualified distributions—distributed assets not used for qualified education expenses—the amount of a distribution that is attributable to earnings is subject to income tax and an additional 10 percent penalty tax unless a penalty tax exception applies.

Penalty Tax ExceptionsThe 10 percent penalty tax on the taxable portion of a distribution does not apply if the recipient qualifies for one of the following penalty exceptions.

• Death

• Disability

• Designated beneficiary received a scholarship or certain other types of educational assistance (defined in IRS Publication 970)

• Distribution made for attendance at a U.S. military academy (within the allowable limits)

ESA Distributions • 45




• Distribution taken into account in determining an American Opportunity or Lifetime Learning tax credit for the same year

• Excess removed before June 1 of the year following the year for which the excess contribution was made

For purposes of determining whether an individual is disabled, the term “disabled” means unable to engage in any substantial gainful activity by reason of any medically determinable physical or mental impairment that may result in death or be of long-continued and indefinite duration (IRC Sec. 72(m)(7)).

Prohibited TransactionsProhibited transaction rules apply to a number of different plans, including ESAs. Prohibited transactions occur when a disqualified person improperly uses plan assets (IRC Secs. 4975(c) and 4975(e)). If the ESA is engaged in a prohibited transaction listed in IRC Sec. 4975, the individual’s ESA is considered disqualified as of the first day of the tax year in which the transaction occurred (IRC Secs. 530(e) and 408(e)(2)(A)). If an ESA is disqualified, the following tax consequences apply.

• The ESA’s value as of the first of the year is treated as if distributed to the designated beneficiary and must be included in her income for that year.

• The distribution generally is subject to the 10 percent penalty tax.

If someone other than the designated beneficiary engages in a prohibited transaction, that person may be subject to certain taxes. A 15 percent penalty tax generally is assessed on the amount of the prohibited transaction and a 100 percent additional penalty tax if the transaction is not corrected. (See Chapter 6, Miscellaneous Compliance, for more on prohibited transactions.)

Qualified and Nonqualified Distributions

When ESAs were first created, their exclusive purpose was to pay for the designated beneficiary’s qualified higher education expenses at an eligible educational institution. The Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) brought notable changes to the definition of “qualified” education expenses. One change is that ESA assets may be used for elementary and secondary (kindergarten through grade 12) expenses at eligible educational institutions in addition to postsecondary education expenses (IRC Sec. 530(b)(2)(A)(ii)).

Whether used for qualified expenses or not, financial organizations report all ESA distributions on Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530) (see Chapter 5, ESA Reporting).

Qualified Education ExpensesThe net education expense paid for a designated beneficiary, which determines taxation of distributions from the designated beneficiary’s ESA, is the total of the following.

• Qualified elementary and secondary education expenses

• Qualified higher education expenses

The total of these expenses is reduced by the amount of qualified scholarships, educational assistance allowances, and educational payments that are excluded from income (other than gifts from family and friends).

46 • ESA Distributions

https://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleA-chap1-subchapB-partII-sec72.htm






Effective for tax years after December 31, 2014, computer equipment, software, Internet access, and related services are considered qualified higher education expenses. This provision was part of the Consolidated Appropriations Act of 2016 signed into law on December 18, 2015.

At Least Half-Time StudentA student is considered to be enrolled at least half-time if the student takes at least half the normal academic workload for her course of study. What constitutes half of the normal full-time workload is determined under the standards of the educational institution where the student is enrolled. The institution’s standard for full-time workload must equal or exceed the standards established by the Department of Education under the Higher Education Act of 1965 (IRC Sec. 529(e)(3) and IRC Sec. 25A(b)(3)).


Qualified elementary and secondary expenses

Expenses for tuition, fees, academic tutoring, special needs services, books, supplies, and other equipment that are incurred in connection with the enrollment or attendance of the designated beneficiary as an elementary or secondary school student at a public, private, or religious school. (An eligible school is any school that provides kindergarten through grade 12 education, as determined under state law.)

Expenses for room and board, uniforms, transportation, and supplementary items and services (including extended day programs) that are required or provided by a public, private, or religious school in connection with such enrollment or attendance.

Expenses for the purchase of computer technology, equipment, or Internet access and related services, if the beneficiary and the beneficiary’s family use such technology, equipment, or services during any of the years the beneficiary is in elementary or secondary school (expenses for computer software designed for sports, games, or hobbies are not included unless the software is predominantly educational in nature).

Qualified higher education expenses

Tuition, fees, books, supplies, and equipment required for the enrollment or attendance of a designated beneficiary at an eligible educational institution. (An eligible educational institution includes any institution that participates in student aid programs administered by the Department of Education.)

Expenses for the purchase of certain computer or peripheral equipment, computer software, or Internet access and related services if used primarily by the designated beneficiary during enrollment at an eligible postsecondary school.

Certain room and board expenses for students who are at least half-time.

Expenses for special needs services that are incurred in connection with enrollment or attendance at an eligible institution.


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Eligible Educational InstitutionFor the purposes of ESAs, an eligible educational institution is either an eligible postsecondary school or an eligible elementary or secondary school. Eligible postsecondary schools include any college, university, vocational school, or other postsecondary educational institution that is eligible to participate in the student aid programs administered by the Department of Education. An eligible educational institution includes virtually all accredited public, nonprofit, and private postsecondary institutions.

Eligible elementary or secondary schools include any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12) as determined under state law.

Room and Board ExpenseThe limit on the amount that is considered reasonable for room and board expenses is dependent upon the specific educational institution attended. Therefore, the designated beneficiary or responsible individual must contact the educational institution for its qualified room and board expenses.

Qualified Tuition ProgramsContributions to qualified tuition programs (QTPs) (IRC Sec. 529 plans) are considered qualified expenses for ESA distributions. Because of this, ESA assets can be transferred to a QTP.

Additional Deduction or CreditA designated beneficiary may not claim an additional income tax deduction or credit on his income tax return for education expenses if such expenses were paid for with an ESA distribution. EGTRRA provided that a taxpayer may claim the American Opportunity credit or Lifetime Learning credit for the same year that ESA distributions on behalf of the same designated beneficiary are excluded from income, provided the taxpayer does not use the ESA distribution to cover the same education expenses claimed for either of the credits. (See Publication 970 for information on these education tax credits.)

Nonqualified DistributionsIf a designated beneficiary withdraws amounts from an ESA that exceed the qualified higher education expenses for the same year, a portion of the distribution generally is taxable. The amount in excess of the qualified education expenses is taxable pro rata, based on the earnings and basis (the contributions) in the designated beneficiary’s ESAs. ESA distributions that are not used to pay for qualified education expenses are taxed in the same manner as Traditional IRA distributions following the provisions of IRC Sec. 72 (i.e., similar to the pro rata return of nondeductible contributions).

Because ESA contributions are gifts, all distributed assets (even excess contributions) belong to the designated beneficiary. As a result, all taxes due on distributions are the responsibility of the designated beneficiary, even though only the responsible individual can request the distribution. Financial organizations are not responsible for calculating the taxable portion of distributions. IRS Publication 970 provides a worksheet that the designated beneficiary (or guardian) can use to calculate the taxable amount of distributions.

Following is an example of how the taxable amount may be calculated when the designated beneficiary’s qualified expenses are less than her distributions.



https://www.gpo.gov/fdsys/pkg/USCODE-2013-title26/html/USCODE-2013-title26-subtitleA-chap1-subchapB-partII-sec72.htm


EXAMPLE: Sarah took a $6,000 distribution in 2022 from her ESA, but only $4,500 was used for qualified education expenses for the year. The amount of basis (contributions) in her ESA on December 31, 2021, is $10,000. No contributions were made for 2022. The ESA balance on December 31, 2022, is $9,000. The following formula shows how the taxable amount may be calculated. But Sarah could use the worksheet in Publication 970 to calculate the taxable portion of her distribution.

Step 1: Determine the nonqualified amount.

Total distribution – Qualified expenses = Nonqualified distribution

$6,000 – $4,500 = $1,500 Nonqualified distribution

Step 2: Apply the following formula to determine the nontaxable (tax-free) amount of the distribution.

Total contributions for the distribution year +

Nonqualified Total basis at prior year-end Nontaxable x –––––––––––––––––––––––––––– = distribution Distribution year ending balance amount

+ Total distributions during distribution year

$10,000 ($0 + $10,000)$1,500 x –––––––––––––––––––––––– = $1,000 Nontaxable amount $15,000 ($9,000 + $6,000)

Step 3: Determine the taxable amount.

Nonqualified distribution – Nontaxable amount = Taxable amount

$1,500 – $1,000 = $500 Taxable amount

Correcting Excess Contributions

Excess contributions may occur in an ESA and an excess contribution penalty tax of six percent may apply. The designated beneficiary will not have to pay the penalty tax for excess contributions if the excess and net income attributable (NIA) is removed before the first day of the sixth month following the taxable year (i.e., no later than May 31) (IRC Sec. 530(d)(4)(C)).

If an individual removes the ESA excess plus NIA after filing her tax return but before the deadline for correcting the excess, she may have to file an amended tax return. Individuals must report any earnings removed with the excess as income for the year the excess contribution was made.

Financial organizations report the distribution of excess contributions in the year they are withdrawn from the ESA, but no corrective reporting is required for the contribution that is reported on Form 5498-ESA, Coverdell ESA Contribution Information.

IRC Secs. 7508 and 7508A govern extensions for completing certain tax acts for members of the Armed Forces and people affected by presidentially declared disaster areas. Treasury Regulation (Treas. Reg.) 301.7508A-1(c)(1) and Revenue Procedure 2007-56 list the acts that may be postponed, and included on the list is the correction of excess contributions.








Types of ExcessesESA excess contributions generally may be categorized into three types.

1. Contributions that exceed the annual maximum contribution amount ($2,000) per designated beneficiary.

2. Contributions that exceed the contributor’s contribution limit based on the contributor’s MAGI (see Chapter 3, ESA Contributions, for contributor eligibility).

3. Contributions made after the designated beneficiary turns age 18, unless the designated beneficiary has special needs.

Correcting Excess Contributions to Avoid the Penalty TaxFinancial organizations often help determine the amount that should be distributed to correct excess contributions and the NIA. Although they are not required to make these determinations, the financial organization has all the information needed for the calculation, including balances on specific dates. When an excess contribution is removed with the NIA, only the NIA is considered taxable income.

Calculating the NIANotice 2003-53 indicates that individuals should compute NIA using the same method for calculating NIA for IRA excess contributions (IRC Sec. 408(d)(4) and Treas. Reg. 1.408-11). Individuals determine NIA by allocating a pro rata portion of the net income on the ESA assets (whether positive or negative) during the period the ESA held the contribution. This method bases the calculation on a computation period beginning with the day the ESA excess contribution was made.

Excess contribution x Total earningsNIA = –––––––––––––––––––––––––––––––––– Adjusted opening balance

Total earnings is the net income earned on the entire ESA (calculated by subtracting the ESA’s adjusted opening balance from the adjusted closing balance), minus any applicable loss of earnings penalty.

Computation period is the period beginning immediately before the time the excess contribution is made and ending on the date of distribution.

Adjusted opening balance is the ESA’s fair market value at the beginning of the computation period, plus any contributions (including rollovers, transfers, and the excess contribution) made to the ESA during the computation period.

Adjusted closing balance is the ESA’s fair market value at the end of the computation period, plus any distributions (including rollovers and transfers) taken from the ESA during the computation period.




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EXAMPLE: On August 1, 2021, Michael deposits $3,000 to his son Logan’s ESA at First Bedrock Financial Organization. On February 15, 2022, when preparing his tax return, Michael realizes that Logan’s ESA has an excess contribution because the maximum contribution amount is $2,000. The balance in Logan’s ESA on August 1 before making the contribution was $1,650. The balance of Logan’s ESA on February 15, 2022, is $4,850. In assisting Michael, First Financial Organization determines the NIA to be $43.01. The NIA is calculated as follows.

Excess contribution = $1,000

Total earnings = $200 = ($4,850 + $0) – ($1,650 + $3,000)

Adjusted opening balance = $4,650 = ($1,650 + $3,000)

$1,000 x $200––––––––––––– = $43.01 NIA $4,650

First Financial Organization has Michael complete a withdrawal statement. The organization issues a check for $1,043.01. The $43.01 is taxable income to Logan in 2021, the year the contribution was made.

NIA Clarifications• If an ESA is not valued on a daily basis, the fair market value at the beginning of the computation

period is deemed to be the most recent, regularly determined, fair market value of the asset.

• If an individual owns more than one ESA, the NIA calculation is performed on the ESA containing the excess contribution being returned, and the distribution must be made from that ESA.

• If an ESA has received more than one contribution for a particular tax year, the last contribution (not transfer or rollover) made to the ESA is deemed to be the contribution that is distributed and a single computation period applies.

• NIA is based on the ESA’s overall value, not on the return of specific assets.

Reporting Excess Removal Before the Applicable DeadlineThe financial organization must report the distribution of an excess contribution on Form 1099-Q. The instructions to Form 1099-Q and Notice 2003-53 indicate that the financial organization should report the gross distribution (excess and NIA) in Box 1, Gross distribution, and only the NIA in Box 2, Earnings. In addition, the organization should indicate in the blank box on the form that the amount in Box 2 represents earnings on excess contributions.

Financial organizations are not required to use distribution codes on Form 1099-Q. But if doing so, one of two distribution codes may be entered in the blank box on the form.

• Code 2 if the contribution that created the excess was deposited in the same year it is removed

• Code 3 if the contribution that created the excess was deposited in the year before it is removed

If the distribution of an excess contribution occurs in the same year that other distributions are made, financial organizations must report the excess distribution on a separate Form 1099-Q.





Excess Contributions Removed After the Applicable DeadlineTax laws provide that excess ESA contributions that are not removed before the deadline (generally June 1) are treated as contributions (i.e., carried forward) for the next year, but the designated beneficiary will have to pay a six percent penalty tax for the year the excess contribution was made. If an excess contribution is carried forward to the next year, contributions for the next year must be reduced to compensate for the excess amount carried forward. The designated beneficiary is liable for a six percent penalty tax on the excess contribution amount for each year it remains an excess contribution.

Determining the Amount of the Excess ContributionPublication 970 provides the following formula to determine the amount of an ESA excess contribution that is subject to the six percent penalty tax. Note that excess contributions are reduced by distributions.

The excess contribution amount =

1. the excess contributions for the current year,

plus

2. any excess contributions remaining from the preceding year,

minus

3. any distributions made during the current year.

Applying an Excess Contribution to the Following YearIf the responsible individual does not distribute the excess amount, the excess contribution is carried forward to subsequent years (until the excess amount is gone). In this situation, the designated beneficiary pays a six percent penalty tax for the year the excess contribution is made, and contributions made in the following year must be reduced by the excess amount so that it does not exceed the $2,000 contribution limit for that year.

The six percent penalty tax is reported on behalf of the designated beneficiary on IRS Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts. While financial organizations do not calculate the additional penalty for taxpayers, some knowledge of the procedure may be helpful.

EXAMPLE: In 2021, Tammy’s parents and grandparents contributed a total of $2,300 to Tammy’s ESA, creating an excess contribution of $300. Tammy did not take any ESA distributions in 2021. Because Tammy did not withdraw the excess before June 1, 2022, she has to pay an additional tax of $18 (6% x $300) for 2021. In 2022, excess contributions of $500 were made to her ESA. Tammy withdrew $100 in 2022 for qualified education expenses. Tammy figures the excess contribution in her account at the end of 2022 as follows.

$500 excess contribution in 2022+ $300 excess contribution in 2021– $100 distribution in 2022–––––––––––––––––––––––––––––––– $700 excess at end of 2022

Tammy will have to pay $42 in penalty taxes for 2022 ($700 x 6%). If Tammy limits 2022 contributions to $1,300 ($2,000 maximum allowed – $700 excess contributions from 2022), she will not owe an additional excess contribution penalty tax in 2023.



https://www.irs.gov/pub/irs-pdf/f5329.pdf

Terminating ESAs Upon Age 30

Within 30 days after the designated beneficiary turns age 30, any assets remaining in the ESA should be distributed to the designated beneficiary or the ESA may be transferred to an ESA for a qualifying family member (see Chapter 1, Introduction to Coverdell ESAs, for qualified family members). The age 30 restriction is waived for designated beneficiaries identified as having special needs (IRC Sec. 530(b)(1)). “Special needs” is not yet defined in official IRS guidance, but the Conference Agreement notes for EGTRRA indicate the intent of Congress is to include individuals who require additional time to complete their education because of physical, mental, or emotional conditions (including learning disabilities).

Form 5305-E, Coverdell Education Savings Trust Account, and Form 5305-EA, Coverdell Education Savings Custodial Account, require financial organizations to distribute any balance remaining in the ESA on the date the designated beneficiary turns age 30 (except for special needs beneficiaries) to the designated beneficiary within 30 days. Financial organizations that use disclosure statements with their ESA plan agreements should look for procedures outlined in the disclosure statement for making these distributions.

If the assets are still in the ESA on the 30th day, the tax laws treat the ESA assets as being distributed to the designated beneficiary on the 30th day. Financial organizations must report this deemed distribution on Form 1099-Q. Any subsequent distribution of the account should not be reported.

Death Beneficiary Distributions

Upon the designated beneficiary’s death, the financial organization generally must distribute the ESA balance to the designated beneficiary’s estate within 30 days after the date of death unless a death beneficiary is named under the ESA (IRC Sec. 530(d)(8)). If a named death beneficiary is a qualified family member under the age of 30, the death beneficiary assumes the ESA as his own upon the designated beneficiary’s death (see Chapter 1, Introduction to Coverdell ESAs, for qualified family members). Consequently, the ESA retains its status and no tax consequences result from the transfer of ownership. The age 30 limitation may be waived for designated death beneficiaries with special needs.

If the death beneficiary does not qualify to be the designated beneficiary, however, then all of the assets in the ESA must be distributed to the death beneficiary within 30 days of the date of death. If the named death beneficiary dies before the designated beneficiary, then the ESA assets must be distributed as if that death beneficiary had not been named.

Reporting Distributions to Death BeneficiariesA financial organization must report all ESA distributions on Form 1099-Q, including distributions to death beneficiaries. The financial organizations should report death distributions in Box 1 of Form 1099-Q, and, if possible, the earnings portion in Box 2 and the basis in Box 3. The Coverdell ESA checkbox in Box 5 should be checked. Box 6 should be checked for distributions to death beneficiaries, including estates if no death beneficiary is named or if benefits default to the estate. Code 5, Death, may be entered in the blank box below Boxes 5 and 6. (See Chapter 5, ESA Reporting, for more on how to report basis and earnings, including a waiver of this requirement.)








Distribution Procedures

Financial organizations generally must take direction from the ESA responsible individual for ESA distributions. As noted in Chapter 1, Introduction to Coverdell ESAs, the designated beneficiary could become the responsible individual upon the age of majority if allowed so in the ESA application or plan agreement.

When a responsible individual requests a distribution from an ESA, the financial organization administering the account should document the distribution to verify accurate distribution reporting later. The IRS requires all ESA distributions (including transfers and rollovers) to be reported on Form 1099-Q.

The following procedures will help ensure compliance with ESA distributions.

1. The financial organization may require the responsible individual to complete an ESA withdrawal form that requests the following information.

• Designated beneficiary’s identifying information

• Amount (including the amount of basis and earnings, if applicable)

• Reason (e.g., normal distribution, withdrawal of excess contributions, death)

• Payment method

• Responsible individual’s signature

3. The financial organization should provide a copy of the withdrawal form to the responsible individual and to the designated beneficiary (or guardian).

4. The financial organization should retain all documentation related to the distribution so that it may be referenced for reporting the distribution on Form 1099-Q.

See Chapter 5, ESA Reporting, for more information on reporting ESA distributions.

No Income Tax WithholdingESA distributions are not subject to federal income tax withholding. In addition, most states do not require withholding from ESA distributions. Financial organizations should check with their state revenue departments to determine the rules that apply for the states.

Compliance Check

A “Coverdell ESA Distribution Log Sheet” may be helpful in documenting ESA distributions, and can be used to verify proper reporting of the distributions. Financial organizations should document the reason for the distribution, the form used, whether signatures were obtained, and if copies were provided to the proper parties.



Coverdell ESA Distribution Log Sheet




Address _________________________________________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Distribution Type

DISTRIBUTION Type of distribution: Normal

Excess withdrawn in same year deposited

Excess withdrawn in year after deposited

Disability

Prohibited transaction

Date_________________ Amount of withdrawal ________________________

Transaction information: Form used __________________________ Revision date ___________________

Signed/dated by responsible individual: Yes No

Explain: ____________________________________________________________

Copy to designated beneficiary: Yes No

Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


DEATH BENEFICIARY Death beneficiary name ______________________________________________

Date of birth____________ Social Security number _______________________

Address ____________________________________________________________

Distribution requested: Yes No NA


Qualified family member assumes as own: Yes No

Date_________________ Amount _____________________________________


Withdrawal taken in year of death: Yes No

Type of beneficiary:

Qualified family member

Estate

Other ___________________________________________________________

Distribution requested and signed/dated by death beneficiary:

Yes No

Explain: ____________________________________________________________

Distribution requested and signed/dated by responsible individual:

Yes No

Explain: ____________________________________________________________

Copy to death beneficiary: Yes No

Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


Chapter 5

ESA ReportingReporting Requirements

IRS Form 5498-ESA

IRS Form 1099-Q

Reporting Corrections

Year-End Statement

Compliance Check

Reporting Requirements

A financial organization that offers Coverdell ESAs is responsible for government reporting and is subject to penalties for failing to file correct reports (IRC Sec. 530(h) and IRC Sec. 6693(a)). Financial organizations report contributions on Form 5498-ESA, Coverdell ESA Contribution Information, and distributions (including transfers and rollovers) on Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530).

Financial organizations may have ESA reporting completed by data processing firms or administration companies, or they may do their own reporting. Financial organizations are ultimately responsible for any penalties imposed for incorrect reporting, even if the required reports are generated by entities outside of their ESA departments.

The information needed to facilitate accurate reporting should be gathered at the time a reportable ESA transaction occurs. The transaction forms a financial organization uses, such as ESA contribution and withdrawal forms, should contain all of the information necessary for generating required reports.

Who Receives Required ReportsFinancial organizations must send required ESA reports to the IRS and to the designated beneficiary. The ESA model forms (Form 5305-E, Coverdell Education Savings Trust Account, and Form 5305-EA, Coverdell Education Savings Custodial Account) state that the ESA trustee or custodian agrees to submit required reports to the IRS and responsible individual as prescribed by the IRS.

ESA Reporting • 57







When seeking clarification regarding which parties should receive copies of the IRS reports, an IRS official commented to Ascensus that financial organizations using IRS model ESA forms or forms based on the models may send copies of the forms to both the ESA designated beneficiary and responsible individual, or may send the IRS forms to the designated beneficiary and ESA statements to the responsible individual. Often the responsible individual is the designated beneficiary’s parent or guardian who receives the reports sent to the designated beneficiary. Financial organizations should review their documents to determine who to send the reports to.

Reporting DeadlinesESA reporting deadlines are stated in the specific instructions for the forms and are scattered throughout the calendar year. The deadlines for filing IRS forms occasionally may fall on a date on which regular business is not conducted by financial organizations or the U.S. Postal Service. IRC Sec. 7503 indicates that when the last day prescribed under the authority of internal revenue laws for performing an act falls on a Saturday, Sunday, or legal holiday, the execution of such act will be considered timely if it is completed on the next day that is not a Saturday, Sunday, or legal holiday. Note that IRC Sec. 7503 does not grant an extension; it is simply an authorization to complete a transaction on the next day that regular services will be conducted.

ESA Reporting TimelineThe following deadlines generally apply to reporting of Forms 1099-Q and 5498-ESA, but note the deadlines adjusted for weekend and/or holiday dates in the 2021 timeline that follows.

• A contribution information statement (e.g., copy B of Form 5498-ESA or an acceptable substitute) generally is due April 30 to the ESA designated beneficiary.

• Form 5498-ESA generally is due May 31 to the IRS.

• Form 1099-Q generally is due January 31 to the ESA designated beneficiary, and to the IRS by February 28 if filing on paper and March 31 if filing electronically.

Timeline for 2021 ESA Reports

Tim89line for 2014 ES8A Reports

How to Receive a Filing Extension A financial organization may file Form 8809, Application for Extension of Time to File Information Returns, to request an extension of time to file reports with the IRS. Form 8809 is used to request an extension for many forms, including Forms 1099-Q and 5498-ESA. Form 8809 is filed to request a 30-day filing extension. The form instructions indicate the extension request should be filed as soon as it is known that an extension is necessary, but must be filed by the due date of the return. Extensions cannot be granted if requests are filed after the due date of the original returns.

58 • ESA Reporting

Form 5498-ESA due to the designated beneficiary

April 30, 2022

Form 5498-ESA due to the IRS

May 31, 2022

Form 1099-Q due to the designated

beneficiary

March. 31, 2022

Form 1099-Q due to IRS

February 28, 2022, for paper

filers

March 31, 2022, for electronic

filers





Method of Submitting Extension RequestThe instructions for Form 8809 indicate that extensions may be requested electronically through the IRS’ Filing Information Returns Electronically (FIRE) system, online by completing a fill-in form in the FIRE system, or on paper. When using the online fill-in method, approvals are automatically displayed online if the request is made by the due date of the return. The required format to request an extension through the FIRE system is described in IRS Publication 1220, Specifications for Electronic Filing of Forms 1097, 1098, 1099, 3921, 3922, 5498, and W-2G.

Automatic 30-Day Extension Treasury regulations allow an automatic 30-day extension for filing certain information returns, including Forms 1099-Q and 5498-ESA, with the IRS (Treasury Regulation 1.6081-8), and this is done with the first filing of Form 8809. No signature or explanation is required on Form 8809 to obtain the automatic extension. As a result, a financial organization that completes the remaining portions of Form 8809 properly and files Form 8809 on or before the date prescribed for filing the particular information return will automatically qualify for the 30-day extension.

Financial organizations that need an additional extension beyond the automatic 30 days must file Form 8809 a second time before the first extension period expires (see the instructions for Form 8809 for details).

Required Information The general information needed to submit the request on Form 8809 is as follows.

• Filer name, address, tax identification number, telephone number, and contact name

• Filing method (paper or electronic)

• Identification of the form type

• Reason for the needed extension if applying for a second extension

• Requestor’s signature (or other authorized person) if applying for a second extension

Extensions may be requested for only one tax year at a time. A separate Form 8809 should be used for each method of filing (i.e., paper or electronically). If requesting an extension to file more than one type of return (e.g., Form 1099-Q and Form 5498-ESA), only one Form 8809 need be submitted as long as the method of filing is the same and the request is filed by the earliest due date. But more than one Form 8809 may be filed to avoid any associated problems.

Filing Extensions for Recipient CopiesFinancial organizations also may request an extension of time to submit information returns to recipients. They must do so by submitting a letter to the IRS at the IRS address given in Publication 1220. Neither the paper Form 8809 nor the online fill-in Form 8809 extension option can be used to request an extension of time to provide information returns to recipients. The following information must be addressed in the letter.

• Payer name

• Payer TIN

• Payer address

• Type of information return

• Statement that the extension request is to provide information returns to recipients





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• Reason for the extension request

• Signature of payer or authorized person

The letter request must be postmarked no later than the return due date to recipients. Requests for late delivery to recipients are not automatically approved. If approved, the IRS will allow for an extension of up to 30 days from the due date of the return. (See Publication 1220 for more details.)

Methods of Filing Information ReturnsThe IRS provides different methods to file information returns, including Form 1099-Q and Form 5498-ESA. The allowed methods are paper filing, which the IRS scans during processing, or filing electronically. Depending on the number of returns being filed (generally 250 or more), a financial organization may be required to file information returns, including corrected returns, electronically.

Some forms are posted at the IRS website for information purposes and may not be downloaded and filed with the IRS. However, the IRS states in the Instructions for Form 5498-ESA that due to a low volume of paper Form 5498-ESA reports, it converted Form 5498-ESA to an online fillable format. Financial organizations may complete Form 5498-ESA online and send Copy B to the recipient. For reporting to the IRS, however, financial organizations that are required to file electronically must continue to do so, and if eligible to file on paper, a black and white Copy A may be submitted to the IRS along with a Form 1096, Annual Summary and Transmittal of U.S. Information Returns.

Financial organizations can obtain official IRS forms from any IRS district office or can order online at www.IRS.gov/orderforms. Instructions on how to file electronically are contained in IRS Publication 1220, which also may be accessed at the IRS website.

Transmittal Forms for Paper ReportingIRS Form 1096, Annual Summary and Transmittal of U.S. Information Returns, is used to transmit paper Forms 1099-Q and 5498-ESA to the IRS. A separate Form 1096 must be used for each type of return transmitted to the IRS (e.g., all paper Forms 1099-Q are sent to the IRS with one Form 1096 and all paper Forms 5498-ESA are sent to the IRS with a separate Form 1096).

Electronic Filing of Information Returns Financial organizations that file 250 or more of any return are required to file those returns electronically. But the IRS encourages all filers to file electronically even if filing fewer than 250 returns. Returns are filed using the IRS’ FIRE system as explained in Publication 1220.

NOTE: Effective for all forms filed after December 31, 2021, proposed regulations would require organizations that file 100 or more forms in aggregate to file electronically. For forms filed after December 31, 2022, the threshold would be further reduced to 10 forms. As of this writing, the regulations had not yet been finalized.

Previously, financial organizations applying to use electronic filing for the first time had to complete and submit Form 4419, Application for Filing Information Returns Electronically (FIRE), by November 1 of the year before the due date of the form(s) (e.g., Forms 1099-Q and 5498-ESA). Effective September 26, 2021, Form 4419 was replaced by the online Information Return (IR) Application for Transmitter Control Code (TCC).





https://www.irs.gov/pub/irs-prior/i5498e--2021.pdf


https://www.IRS.gov/orderforms




https://la2.www4.irs.gov/eauth/pub/login.jsp?Data=VGFyZ2V0TG9BPUY%253D&TYPE=33554433&REALMOID=06-000152df-9e99-1a23-9e93-163b0acf40b7&GUID&SMAUTHREASON=0&METHOD=GET&SMAGENTNAME=UOkC7yx4eMTO24FGxPfBRb5q3Mj3Xh3pyXfBEjYyHJ97nGCXu16wx5MzFHjfZmlG&TARGET=-SM-https%3a%2f%2fla2%2ewww4%2eirs%2egov%2fesrv%2fesam%2fpages%2flandingPage%2exhtml

https://la2.www4.irs.gov/eauth/pub/login.jsp?Data=VGFyZ2V0TG9BPUY%253D&TYPE=33554433&REALMOID=06-000152df-9e99-1a23-9e93-163b0acf40b7&GUID&SMAUTHREASON=0&METHOD=GET&SMAGENTNAME=UOkC7yx4eMTO24FGxPfBRb5q3Mj3Xh3pyXfBEjYyHJ97nGCXu16wx5MzFHjfZmlG&TARGET=-SM-https%3a%2f%2fla2%2ewww4%2eirs%2egov%2fesrv%2fesam%2fpages%2flandingPage%2exhtml

If a payer is required to file electronically but fails to do so and does not have an approved waiver on record, the payer will be subject to a penalty of $100 per return in excess of 250 returns. Waivers for filing reports electronically are granted on a case-by-case basis by submitting Form 8508, Request for Waiver From Filing Information Returns Electronically. One Form 8508 may be submitted for multiple types of returns. These waiver requests must be filed at least 45 days before the due date of the returns.

Substitute FormsA substitute form is a specially designed form that substitutes the official IRS reporting form and meets specific IRS requirements. The IRS permits qualified substitutes for Forms 1099-Q and 5498-ESA, but they must meet the requirements in Publication 1179, General Rules and Specifications for Substitute Forms 1096, 1098, 1099, 5498, and Certain Other Information Returns.

Most financial organizations file their information returns with the IRS electronically. Publication 1179 states that the copy filed with the IRS must be an exact replica of the official IRS form with respect to layout and content. The publication gives specific measurements for each box on the form and each word used. It also dictates specific paper qualities, ink, and typography.

Truncating Identification Numbers Notice 2009-93 introduced an IRS program for information return filers to truncate payees’ identification numbers (Social Security and individual taxpayer identification numbers) on paper payee statements of certain IRS returns. This included Forms 5498-ESA and 1099-Q. Final regulations released in July 2014 in Treasury Decision 9675 made this program permanent and voluntary for information return filers.

Under this procedure, the payee’s identification number is truncated to only the last four digits. The General Instructions for Certain Information Returns indicate that to truncate, the first five digits of the nine-digit identification numbers are replaced with asterisks (*) or Xs. For example, a Social Security number with the last four digits of 1234 may be truncated as ***-**-1234, or as XXX-XX-1234.

The final regulations on truncating identification numbers permit this procedure to be used on any payee statements where the use of the complete tax identification number is not required by statute, regulation, or other guidance. The final regulations also emphasize that financial organizations may not truncate a payee’s identification number on any forms filed with the IRS or with state or local governments.

IRS Form 5498-ESA

Financial organizations must report ESA contributions (including rollovers and trustee-to-trustee transfers) on Form 5498-ESA. Unlike reporting for IRAs, the IRS generally does not require reporting of the fair market value (FMV) on Form 5498-ESA, except for certain circumstances in which it will be included on Form 1099-Q (see “IRS Form 1099-Q” later). Form 5498-ESA and other IRS information returns can be found at the IRS website.

The deadline for providing the ESA designated beneficiary with Copy B of Form 5498-ESA or a substitute Form 5498-ESA generally is April 30 of the following year. The deadline for filing Copy A of Form 5498-ESA with the IRS generally is May 31 of the year following the year for which the contributions are being reported.


https://www.irs.gov/pub//irs-pdf////f8508.pdf

http://www.irs.gov/pub/irs-pdf/p1179.pdf




http://www.irs.gov/irb/2014-31_IRB/ar07.html

https://www.irs.gov/pub/irs-pdf/i1099gi.pdf


2021 Form 5498-ESA

Specific reporting requirements for the 2021 Form 5498-ESA boxes are as follows.

• Box 1 – Enter any current year and prior-year (those made between January 1 and April 15, 2022) ESA contributions.

• Box 2 – Enter any rollover contributions, including military death gratuity rollovers and any direct trustee-to-trustee transfers received by the ESA in 2021.

Financial organizations must provide the account number for the ESA if multiple accounts exist for a recipient and the organization is filing more than one 5498-ESA for that recipient.

Penalty for Failure to Timely Provide Form 5498-ESAThe penalty for failure to provide Form 5498-ESA to the designated beneficiary is $50 per failure (IRC Sec. 6693(a)). A similar $50 penalty applies for failing to file Form 5498-ESA with the IRS when required. See the General Instructions for Certain Information Returns at the IRS website for more information.

IRS Form 1099-Q

Financial organizations report all distributions on Form 1099-Q. Form 1099-Q and other IRS information returns can be found at the IRS website. Trustee-to-trustee transfers to other ESAs and to qualified tuition programs ((i.e., IRC Sec. 529 plans) also are reported on Form 1099-Q. IRS officials confirmed to Ascensus, however, that transfers within the same financial organization (e.g., changing the name of the designated beneficiary on an ESA or transferring ESA assets to a qualified family member’s ESA within the same financial organization) are not reported.

The basis and earnings portions of ESA distributions may be reported as well on Form 1099-Q, but IRS Notice 2003-53 (discussed later) provides temporary relief from reporting basis and earnings.







Financial organizations must provide the account number for the ESA if multiple accounts exist for a recipient and the organization is filing more than one 1099-Q for that recipient.

Form 1099-Q generally must be sent to recipients by January 31 and to the IRS by February 28 for paper filers and March 31 for electronic filers.

Form 1099-Q

Specific ESA reporting requirements for Form 1099-Q are as follows.

• Box 1 – Enter the gross distribution amount.

• Box 2 – Enter the earnings portion of the amount in Box 1 (optional unless reporting net income attributable for excess contributions).

• Box 3 – Enter the basis portion of the amount in Box 1 (optional).

• Box 4 – Check this box if the amount in Box 1 was from one ESA to another ESA at different financial organizations or to a QTP.

• Box 5 – Check the Coverdell ESA box to indicate reporting for an ESA.

• Box 6 – Check this box if the distribution recipient is not the ESA’s designated beneficiary (e.g., a death beneficiary).

Earnings and BasisSome financial organizations may not have accurate information of earnings and basis for the ESA, particularly if the ESA received transfers or rollovers and the financial organization was not given basis and earnings information. The Form 1099-Q instructions indicate that financial organizations that cannot separately report earnings and basis may leave Boxes 2 and 3 blank. If doing so, however, they must enter the fair market value at the end of the year in the blank box below Boxes 5 and 6 and label the amount “FMV” (e.g., a $7,000 FMV may be entered as “FMV 7,000”).



The instructions for Form 1099-Q instruct financial organizations to use the earnings ratio described in Proposed Treasury Regulation 1.529-3 and Notice 2001-81 to determine the earnings (or loss) on the gross amount distributed from an ESA. The formula is as follows.

Total account balance +

Distributions – Total investment( on December 31 during the year )

––––––––––––––––––––––––––––––––––––––––––––––––––––––––– x Distribution amount = Earnings Total account balance

+ Distributions

( on December 31 during the year )

EXAMPLE: Allie took a $4,000 distribution on September 3, 2021, from her ESA. The aggregate investment (amount of contributions) made to Allie’s ESA equals $8,000. The balance on December 31, 2021, was $6,000. The earnings portion reported on Allie’s 2021 IRS Form 1099-Q is determined as follows.

($6,000 + $4,000) – $8,000––––––––––––––––––––––––– x $4,000 = $800 earnings $6,000 + $4,000

The financial organization completes Form 1099-Q as follows.

• $4,000 is reported in Box 1

• $800 is reported as earnings in Box 2

• $3,200 is reported as basis in Box 3

NOTE: Earnings and basis are determined and reported for each account separately.

Trustee-to-Trustee TransfersNotice 2003-53 and the Form 1099-Q instructions also provide relief for reporting transfers on Form 1099-Q. It states that financial organizations may leave Box 4 of Form 1099-Q blank if they do not have records indicating whether an ESA distribution was a trustee-to-trustee transfer.

Optional Distribution CodesFinancial organizations may, but are not required to, use distribution codes as noted in the Form 1099-Q instructions. If using distribution codes, the code must be entered in the blank box below Boxes 5 and 6. Financial organizations may abbreviate code references (e.g., “distr. code 1”). The following codes may be used for 2021 reporting.

1 – Distributions (including transfers)

2 – Excess contributions plus earnings taxable in 2021

3 – Excess contributions plus earnings taxable in 2020

4 – Disability

5 – Death

6 – Prohibited transaction





Reporting Excess ContributionsIf the distribution represents the correction of an excess ESA contribution with net income attributable (NIA), the gross amount must be entered in Box 1 and the NIA in Box 2. In the blank box below Boxes 5 and 6, enter

• code 2 if the contribution that created the excess was deposited in the same year it was removed, or

• code 3 if the contribution that created the excess was deposited in the year before the year it was removed.

Also, the FMV must be entered in the blank box. (See Chapter 4, ESA Distributions, for information on excess contributions.)

Penalty for Failure to Timely File Form 1099-QThe penalty for failing to timely file Form 1099-Q with the IRS or to provide Form 1099-Q to the recipient is $50 for each failure, with no maximum dollar limit, unless the failure is due to reasonable cause (IRC Sec. 6693). See the General Instructions for Certain Information Returns for more information. These instructions can be found at the IRS website.


If a financial organization files Form 5498-ESA or Form 1099-Q with the IRS and later discovers that there is an error on the report, it must correct the error as soon as possible. The General Instructions for Certain Information Returns explains corrections for paper information returns, and Publication 1220 explains corrections for electronic filing.

Financial organizations that send 250 or more corrections of any Forms 5498-ESA or 1099-Q must send the corrections electronically. The limit applies separately to each form. Financial organizations filing less than 250 corrections of any one form may submit using paper copy. (For corrections filed after December 31, 2021, proposed regulations would require organizations to file corrections electronically if the original form was filed electronically. As of this writing, the regulations had not yet been finalized.) When correcting a paper return, financial organizations must file Copy A and Form 1096 with the IRS, and provide statements to recipients showing the correction.

Correction MethodsThe correction method depends on the type of error that is made. The most common errors generally require a single form to make the correction. These errors include incorrect distribution or contribution amounts, incorrect distribution code (if applicable), and incorrect checkbox. Other errors require the submission of two separate reporting forms. For example, correcting an incorrect name requires the two-form correction method. The first form is used to identify the incorrect return submitted to the IRS. The second form is used to report the correct information.










Following is a guide from the General Instructions for Certain Information Returns that indicates how to correct returns based on the type of error made. (See Publication 1220 for guidance on correcting information returns electronically.)




Correction ExampleFollowing is an example of how to do paper corrections when a regular contribution is mistakenly reported as a rollover contribution.

Reporting Incorrect Payer Name and/or TINThe General Instructions for Certain Information Returns states that financial organizations that discover an error in reporting their own name and TIN should write a letter to the IRS containing the following information.

• Payer’s name and address

• Type of error (including the incorrect payer name/TIN that was reported)


Original Form 5498-ESA Submitted

ABC Bank123 Main StreetAnytown, USA 12345

John Jones

3456 Maple Avenue

Anytown, USA 12345

12-3456789 345-67-9456

2000

Corrected Form 5498-ESA

ABC Bank123 Main StreetAnytown, USA 12345

John Jones

3456 Maple Avenue

Anytown, USA 12345

12-3456789 345-67-9456

2000

X


• Tax year

• Payer TIN

• Transmitter control code (TCC), if applicable

• Type of return

• Number of payees

• Filing method (paper or electronic)

• Whether federal income tax was withheld (federal income tax withholding does not apply to ESA distributions)

The letter should be sent to the following address.

Internal Revenue ServiceInformation Returns Branch230 Murall DriveMail Stop 4360Kearneysville, WV 25430

If a large number of incorrect information returns have been filed or if there has been duplicate reporting, the financial organization should call IRS information reporting customer service at 866-455-7438.

Year-End Statement

Although not an IRS requirement, year-end statements similar to account statements for IRAs are recommended for ESAs. This statement is helpful to the designated beneficiary’s guardian (if applicable) and to the responsible individual that is managing the ESA on behalf of the designated beneficiary. If providing a year-end statement, financial organizations should show the contribution activity for the year and the ESA fair market value as of December 31 of the year of the report. The recommended deadline for providing the year-end statement to the designated beneficiary is January 31 to allow responsible individuals ample time to make corrections before the tax filing deadline, if necessary.

Compliance Check

Financial organizations are responsible for the accuracy of ESA reporting. ESA administrators should spot-check a percentage of forms before they are forwarded to the IRS. The reporting forms should be checked against the operational forms (e.g., deposit forms, withdrawal forms) that were completed at the time of the transaction.

The “2021 Coverdell ESA Reporting Activity Log Sheet” is designed to help financial organizations document compliance with reporting requirements. Financial organizations may use the log sheet to track their reporting for the year.


2021 Coverdell ESA Reporting Activity Log Sheet


Reporting year ___________________________________________________________________________________

Form 1099-Q

Format used: Paper Electronic

Due to IRS: February 28, 2022 March 31, 2022

Date sent: ______________________ ______________________

Due to designated beneficiaries: January 31, 2022 Date sent ______________________

Copy to responsible individuals: Yes No Date sent ______________________

Form 5498-ESA


Due to IRS: May 31, 2022 May 31, 2022

Date sent: ______________________ ______________________

Due to designated beneficiaries: April 30, 2022 Date sent ______________________


Year-End Statement (optional)


Format ____________________________________


Form: 1099-Q 5498-ESA

IRS correction: Date sent ______________________

Correction format: Paper Electronic

To designated beneficiary: Name: ___________________________________ Date sent_______________

To responsible individual: Name: ___________________________________ Date sent_______________

Explain: ___________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________


Reporting Corrections (continued)

Form: 1099-Q 5498-ESA



To designated beneficiary: Name: _________________________ Date sent _________________________

To responsible individual: Name: _________________________ Date sent _________________________

Explain: ___________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Form: 1099-Q 5498-ESA





Explain: ___________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Form: 1099-Q 5498-ESA





Explain: ___________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Signature

Employee signature ____________________________________________ Date _______________________


Chapter 6

Miscellaneous ComplianceESA Fees

Prohibited Transactions

Investment Advice

Divorce

ESA File Maintenance

Record Retention

Compliance Check

ESA Fees

Most financial organizations customize the ESA plan agreement language in Article X to address the application of fees associated with the administration of an ESA.

Like IRA expenses, ESA expenses can be split into two basic categories.

1. Sales charges and commissions

2. Administrative expenses

Sales Charges and CommissionsSales charges and commissions are expenses that relate to the purchase, sale, or maintenance of investments for the ESA. Sales charges and commissions are part of the investment cost, and are paid directly from the ESA. The payment of such fees from ESA assets is not a distribution and is not reported on Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530). For IRAs, if the IRA owner pays sales charges or commissions out of pocket, the payment is considered a contribution to the IRA and the organization must report the contribution on Form 5498, IRA Contribution Information, (Revenue Ruling 86-142). Although not specifically addressed by IRS pronouncements, it is reasonable to conclude that this same requirement applies to ESAs.

It may be necessary to liquidate ESA assets to cover sales charges and commissions. The plan agreement typically will address the right of the financial organization to liquidate plan assets in such a case.

Administrative FeesThe second category of expenses is administrative fees. Examples of administrative fees include annual fees, investment advisor fees, transfer fees, and other transaction fees. Most administrative fees are regarded as ordinary and necessary for the maintenance of the ESA.

Miscellaneous Compliance • 71



Although specific guidance on administrative fees for ESAs is not available, financial organizations should apply the same procedures applicable to IRAs. For IRAs, administrative fees that are considered ordinary and necessary may be paid two different ways. The fees may be directly paid from the IRA assets. Paying administrative fees from the IRA is not considered a reportable distribution. When paid from IRA assets, the fee payment is characterized as an expense and decreases the IRA balance. This would apply to ESAs as well.

Alternatively, IRA owners may pay administrative fees out of pocket to the financial organization. The direct payment of administrative fees by the IRA owner is not considered a contribution. But reimbursing an IRA for fees taken directly from the IRA is a reportable contribution. Organizations may also handle ESA administrative fees in this manner. The organization may bill ESA administrative fees separately to the designated beneficiary. The responsible individual, acting on behalf of the designated beneficiary, would likely facilitate the direct payment of the administrative fee. Plan agreements typically determine which method of payment is permissible.

ESA administrators should do two things when dealing with ESA fees.

1. Determine if the fee is integral to the maintenance of the ESA itself or of a particular investment. This will dictate whether the designated beneficiary may pay the expense or if it is paid by the ESA.

2. Review the ESA plan agreement to see if it addresses fees. If so, follow the instructions given in the plan agreement.

Prohibited Transactions

Prohibited transactions (PTs) occur when a “disqualified” person improperly uses plan assets. IRC Sec. 4975 and 408(e)(2) and (4) define the types of transactions that constitute an improper use of plan (including ESA) assets. IRC Sec. 4975(e) lists those who are considered disqualified persons with respect to a plan.

The purpose of the PT rules is to discourage disqualified persons from dealing with the plan assets (the ESA) in a self-dealing manner. Certain penalties apply when PTs occur. An ESA generally may not be engaged in any of the PTs under IRC Sec. 4975, and may not be invested in life insurance or certain collectibles. ESAs also may not be pledged as security for a loan, and loans may not be taken from an ESA.

Prohibited Transactions Involving Disqualified PersonsIRC Sec. 4975 provides that certain taxes are assessed when disqualified persons participate in PTs involving IRAs, employer-sponsored retirement plans, health savings accounts, and ESAs.

Disqualified PersonsAlthough the definition of “disqualified person” is detailed and complex, some entities will virtually always be considered disqualified persons with respect to ESA transactions. In addition to ESA designated beneficiaries and responsible individuals, disqualified persons for ESAs include fiduciaries (ESA trustees, custodians, and issuers) and relatives of the designated beneficiary. For ESA purposes, a fiduciary generally is any individual who does the following.

• Exercises discretionary authority or control in managing the ESA or exercises any authority or control in managing or disposing of its assets.

• Provides ESA investment advice for a fee, or has any authority or responsibility to do so.

• Has any discretionary authority or responsibility in administering the ESA.

72 • Miscellaneous Compliance




TransactionsIRC Sec. 4975(c) generally provides that transactions between a plan (i.e., ESA) and a disqualified person that are prohibited are any direct or indirect

• sale or exchange, or leasing, of any property between a plan and a disqualified person;

• lending of money or other extension of credit between a plan and a disqualified person;

• furnishing of goods, services, or facilities between a plan and a disqualified person;

• transfer to, or use by or for the benefit of, a disqualified person of the income or assets of a plan;

• act by a disqualified person who is a fiduciary whereby he deals with the income or assets of a plan in his own interest or for his own account; or

• receipt of any consideration for his own personal account by any disqualified person who is a fiduciary from any party dealing with the plan in connection with a transaction involving the income or assets of the plan.

PenaltiesIf the ESA is engaged in a PT listed in IRC Sec. 4975, the individual’s ESA is considered disqualified as of the first day of the tax year in which the PT occurred (IRC Secs. 530(e) and 408(e)(2)(A)). If an ESA is disqualified, the following tax consequences apply.

• The ESA’s value as of the first of the year is treated as if distributed to the designated beneficiary and must be included in her income for that year (IRC Sec. 408(e)(2)(B)).

• The earnings portion of the distribution generally is subject to the 10 percent early distribution penalty tax, unless a penalty exception applies.

If someone other than the designated beneficiary engages in a PT, that person may be subject to certain taxes. There generally is a 15 percent penalty tax on the amount of the prohibited transaction and a 100 percent additional penalty tax if the transaction is not corrected.

LoansIf the value (or portion) of the ESA is pledged as security for a loan, only the pledged portion is considered distributed (IRC Secs. 530(e) and 408(e)(4)). If a loan is made from the ESA to a disqualified person, the account ceases to be an ESA and the account’s fair market value as of January 1 of that year is treated as if distributed on January 1 to the designated beneficiary (IRC Secs. 530(e) and 408(e)(2)(B)).

Collectibles and Life InsuranceESA assets cannot be invested in certain collectibles and may not be invested in life insurance contracts (IRC Secs. 408(a)(3), 408(e)(5)(b), and 408(m)). If ESA assets are invested in either collectibles or life insurance, the investment is treated as a distribution of an amount equal to the cost of the investment.

Banking-Related Services ExemptionUnder Prohibited Transaction Exemption (PTE) 93-2, which was amended and redesignated as PTE 93-33 in 1994, IRA owners and ESA owners (designated beneficiaries) may receive free or discounted services from banks and credit unions under a relationship banking strategy without the owner facing prohibited transaction concerns. PTE 97-11 later gave the same opportunities to broker-dealers.










Reduced- or no-cost service may be provided for ESAs if all of the following conditions are met.

• The ESA that qualifies an individual to receive services is established solely to benefit the designated beneficiary, spouse, or the death beneficiaries.

• The financial organization itself must be legally able to offer the services, consistent with applicable federal and state banking laws.

• The services are provided in the ordinary course of business by the financial organization (or affiliate) to customers who qualify but do not maintain an account with the financial organization.

• The deposit balance required by the organization for the ESA to be included in the relationship banking program must be equal to the lowest balance required for any other type of account that the organization includes in the program.

• The rate of return on an ESA investment is not less than the return on an identical investment that could have been made at the same time at the same branch of the financial organization by a client who is not eligible for (or does not receive) the services.

Relationship Brokerage Services ExemptionPTE 97-11 permits broker-dealers registered under the Securities Exchange Act of 1934 to provide free or low-cost brokerage services to IRA owners without fear of the IRA owner incurring prohibited transactions if several conditions are met. The proposed exemption basically would extend the prohibited transaction relief described in PTE 93-33 to IRA owners who do business with broker-dealers. Amendments to PTE 93-33 and PTE 97-11 extend this exemption to ESAs.

Prohibited Transaction Exemptions Added for ESAsIn PTE 2002-13, the DOL added ESAs and other plans under IRC Sec. 4975(e)(1) to several PTEs. A PTE generally allows for a certain practice that is considered beneficial to a retirement plan, plan participant, or ESA designated beneficiary, but might technically violate the prohibited transaction rules. Those PTEs cited in PTE 2002-13 apply primarily to retirement plans and have minimal effect on ESAs.

Investment Advice

Department of Labor’s Prohibited Transaction Exemption 2020-02Prohibited transaction provisions in IRC Sec. 4975 generally prohibit various types of transactions between ESAs and disqualified persons that may result in self-dealing. Under IRC Sec. 4975, a fiduciary rendering investment advice to an account owner could be considered a disqualified person and therefore providing compensated investment advice could result in a prohibited transaction.

In December 2020, the Department of Labor (DOL) released Prohibited Transaction Exemption (PTE) 2020-02, which addresses how a financial organization or financial professional can receive certain compensation that would otherwise violate the prohibited transaction rules. This DOL class exemption and interpretation, entitled Improving Investment Advice for Workers & Retirees, became effective February 16, 2021. It outlines the factors that determine whether financial professionals—such as those providing investment services to ESA designated beneficiaries, retirement plan participants and beneficiaries, IRA owners and beneficiaries, and plan fiduciaries—are considered fiduciaries themselves. It also gives clear guidance about how fiduciaries must comply with their responsibilities.



https://www.federalregister.gov/documents/2020/12/18/2020-27825/prohibited-transaction-exemption-2020-02-improving-investment-advice-for-workers-and-retirees

https://www.federalregister.gov/documents/2020/12/18/2020-27825/prohibited-transaction-exemption-2020-02-improving-investment-advice-for-workers-and-retirees


The DOL first issued this PTE in proposed form in June 2020, along with a technical amendment to DOL Regulations (Regs.) 2509 and 2510. The guidance was intended to replace the DOL’s 2016 final regulations and accompanying exemptions on fiduciary investment advice, referred to as the “conflict-of-interest” rule. After several implementation delays, the 2016 final regulations were vacated in 2018 by the U.S. Court of Appeals for the Fifth Circuit, which ruled that the DOL had exceeded its authority.

After the 2016 final regulations were vacated in 2018, the DOL issued Field Assistance Bulletin (FAB) 2018-02, which states that the DOL will not pursue prohibited transaction claims against fiduciaries who make good-faith efforts to comply with the Impartial Conduct Standards (discussed next). FAB 2018-02 provides a transition period for parties to develop ways to comply with PTE 2020-02. When issuing PTE 2020-02, the DOL extended the temporary enforcement policy under FAB 2018-02 until December 20, 2021. FAB 2021-02 extended this temporary relief through January 31, 2022. Note that fiduciaries may continue to rely on other existing PTEs.

Impartial Conduct StandardsTo take advantage of the relief provided under PTE 2020-02, investment professionals and financial organizations must provide advice in accordance with the Impartial Conduct Standards, which impose three conditions, or standards.

• The investment advice must be in the retirement investor’s best interest.

• The compensation for the advice must be reasonable.

• The advice, when made, must not be materially misleading.

The Impartial Conduct Standards also require financial professionals and financial organizations to provide the best execution possible when completing security transactions (e.g., completing the transaction timely).

Additional GuidanceTo provide additional information for individuals, employee benefit plans, and investment professionals, the DOL released two pieces of guidance in April 2021. The first piece, entitled New Fiduciary Advice Exemption: PTE 2020-02 Improving Investment Advice for Workers & Retirees Frequently Asked Questions, contains a detailed set of frequently asked questions for investment professionals and financial organizations. The second piece, entitled Choosing the Right Person to Give You Investment Advice: Information for Investors in Retirement Plans and Individual Retirement Accounts, contains a list of questions that retirement savers should consider asking financial professionals before following their recommendations.

SEC Best Interest Standard for Broker-Dealers, Registered Investment AdvisorsThe Securities and Exchange Commission (SEC) issued proposed guidance in April 2018 for broker-dealers and registered investment advisors who provide investment recommendations and investment advisory services to clients. These regulations were adopted as final in June 2019 when the SEC released a guidance package. The rules do not apply to banks or credit unions unless they are (or own) a broker-dealer or a registered investment advisor.

By issuing a guidance package, the SEC is enhancing the broker-dealer standard to meet retail customers’ expectations, and also confirming and clarifying the standard of conduct for investment advisers. The SEC’s finalized package contains the following items.

https://www.dol.gov/agencies/ebsa/employers-and-advisers/guidance/field-assistance-bulletins/2018-02



https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/new-fiduciary-advice-exemption

https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/new-fiduciary-advice-exemption

https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/choosing-the-right-person-to-give-you-investment-advice

https://www.dol.gov/agencies/ebsa/about-ebsa/our-activities/resource-center/faqs/choosing-the-right-person-to-give-you-investment-advice


• The Regulation Best Interest, which establishes a standard of conduct for broker-dealers when making recommendations to retail customers.

• A final rule requiring investment advisers and broker-dealers to provide a client relationship summary (known as Form CRS) to retail investors.

• An interpretation of the standard of conduct for investment advisers.

• An interpretation of the “solely incidental” prong of the Investment Advisers Act of 1940.

Regulation Best Interest (Reg. BI) generally does not apply to traditional bank or credit union products (e.g., certificates of deposit). The guidance package does address activities with respect to securities investments—such as stocks, bonds, and mutual funds—for retail clients. This includes the purchase, sale, exchange, or holding of such investments. In addition, Reg. BI covers retirement plan participants receiving direct investment recommendations for their own account, but excludes employer plans as a business-purpose exception. The guidance also covers investors in individual tax-advantaged accounts such as IRAs, health savings accounts, Archer medical savings accounts, 529 plans, and Coverdell education savings accounts.

Reg. BI and Form CRS became effective September 10, 2019, but included a transition period until June 30, 2020, in order to give firms sufficient time to come into compliance. The “standard of conduct” interpretation and the “solely incidental” interpretation became effective July 12, 2019, when published in the Federal Register.

Divorce

Like IRAs, ESAs are subject to a property division according to the terms of the divorce decree or legal separation instrument (IRC Sec. 530(d)(7)). A divorce decree typically will address the allocation of ESA assets to a former or legally separated spouse of the designated beneficiary (referred to hereafter as former spouse) in one of two ways.

1. The legal document will award the former spouse all or a portion of the ESA assets without specifically designating how the transfer of ownership is to be accomplished.

2. The legal document may specify that the former spouse must transfer all or a portion of the ESA assets into an ESA of his own.

IRS Publication 970, Tax Benefits For Education, indicates that if a former spouse receives an ESA under a divorce or separation instrument and it is transferred to an ESA in the former spouse’s name, it is not taxable and may be maintained as an ESA. After the transfer, the arrangement will be treated as an ESA for which the former spouse is the designated beneficiary (IRC Sec. 530(d)(7)). The possibility of rolling over assets distributed to the designated beneficiary’s former spouse is unclear in IRS written guidance. IRS officials have commented to Ascensus, however, that rollovers may be allowed in the case of divorce or legal separation.

Transfers and rollovers incident to divorce or legal separation are reportable events on Forms 1099-Q and 5498-ESA.

https://www.sec.gov/rules/final/2019/34-86031.pdf

https://www.sec.gov/rules/final/2019/34-86032.pdf

https://www.sec.gov/rules/interp/2019/ia-5248.pdf

https://www.sec.gov/rules/interp/2019/ia-5249.pdf






If the divorce decree or directive calls for a distribution to a former spouse, the ESA administrator generally should distribute the assets directly to the former spouse. In this situation, the financial organization should consider having the former spouse complete a withdrawal form. This will help to gather the necessary information to report the distribution on Form 1099-Q in the name and Social Security number of the recipient (the former spouse). If a distribution is made to the designated beneficiary to meet a financial obligation resulting from a divorce settlement, the distribution should be reported on Form 1099-Q in the designated beneficiary’s name and Social Security number.

The language in the divorce decree or separation agreement must first be reviewed to determine whether a directive for receipt of ESA funds is indicated. If the legal documents or directive is unclear, financial organizations could seek an opinion from their legal counsel. At a minimum, financial organizations should obtain a written, signed statement (often a withdrawal form) from the responsible individual indicating what transaction to use.

ESA File Maintenance

The contents of ESA files vary from organization to organization, depending on how the financial organization stores information and what reporting methods are used. Ideally, an individual should be able to open an ESA file and trace the ESA’s complete history. Each ESA transaction should have paperwork documenting how it was carried out. Records may be stored electronically or on paper. Financial organizations using this method should ensure that the reporting is readily accessible to check if necessary.

The ideal ESA file should contain most of the ESA material listed in the following sections. Following these recommendations will help to ensure that ESA files are maintained in compliance with IRS guidelines.

ESA File ContentsThe following information should be retained in each designated beneficiary’s ESA file.

• An executed ESA plan agreement (Form 5305-E, Coverdell Education Savings Trust Account, or 5305-EA, Coverdell Education Savings Custodial Account), and a copy of the disclosure statement (if provided) or an acknowledgment by the grantor/depositor that she received a plan agreement and disclosure statement

• Information that may be required to satisfy the financial organization’s Customer Identification Program (CIP)

• Amendments to the plan agreement and disclosure statement occurring after the ESA was opened (or a master file containing all amendments with the names and addresses of designated beneficiaries, responsible individuals, and possibly grantors/depositors that were sent such amendments)

• Any death beneficiary designation, the death beneficiary’s birth date (needed to help process death distributions), and beneficiary designation changes

• Deposit information, including the contribution form signed by the grantor/depositor or contributor showing the date the contribution was made, the contribution amount, the contribution type, and deposit terms or rules, such as the certificate of deposit or share certificate contract

• Withdrawal information including a withdrawal statement or request, signed by the ESA’s responsible individual

• Any documentation or correspondence relating to a transfer




• Any documentation or correspondence relating to a rollover

• Any documentation or correspondence relating to death claims, such as

– a certified copy of the death certificate

– executed withdrawal form or other instructions from the estate representative or death beneficiary

– certified copy of Letters Testamentary or Letters of Administration (from the issuing County or Probate Court) if no death beneficiary is designated (if applicable)

– an affidavit of a successor of the decedent (if applicable, when the value of the entire probate estate is a small amount and the estate will not be probated)

• Any documentation or correspondence relating to divorce claims

• Any documentation that substantiates the “special needs” status (as that term is applied by the IRS) of a designated beneficiary

ESA Master FileA master file is a file containing all pertinent information relating to a specific operation of the ESA program. The information in this file generally is what the IRS will request when conducting an audit.

The master file should contain the following.

Opening Documents• ESA application and plan agreement (current and past versions)

• Disclosure statement (if applicable)

• Death beneficiary forms

• Dates that various document versions were used

• Mailing list of recipients

Transaction Forms• Contribution and investment selection forms

• Contribution eligibility forms

• Withdrawal forms

• Transfer request forms

Amendment Files• Amendments (maintain a separate file for each amendment)

• Cover letters

• Mailing list of recipients

• Dates that documents were sent


Record Retention

Financial organizations administering ESAs constantly generate operational and reporting forms to document ESA transactions. Paper, microfiche, discs, files, and boxes of data accumulate. ESA administrators eventually begin to question what records need to be kept and for how long.

Unfortunately, no one source contains the record retention requirements for ESAs. The retention of various types of records is governed by a number of laws and different sources (e.g., the Federal Deposit Insurance Corporation, National Credit Union Administration, Federal Deposit Insurance Act, USA PATRIOT Act, Bank Secrecy Act). Financial organizations should check with their regulatory agencies, legal counsel, and state laws to determine how they should retain their ESA records.

Documentation to RetainFinancial organizations generally should keep documentation necessary to reconstruct a transaction. Each financial organization should retain either the original or a copy of the following records.

• All operational forms, including copies of all ESA applications and other transaction forms

• Documents granting signature authority for each deposit or share account (ESA opening documents, contribution forms)

• Statements, ledger cards, or other records on each deposit or share account, showing each transaction that occurred with the ESA

• All checks, drafts, and money orders the financial organization issues in connection with the ESA and documents relating to cash withdrawals or wire transfers

• Tax reporting information, including the records necessary to reproduce IRS Forms 1099-Q and 5498-ESA

• Records necessary to document investment transactions

In addition, laws and regulations may require retention of other records associated with ESA transactions.

Maintaining Records ElectronicallyFinancial organizations may retain IRA records in various forms: hard copies, photocopies, computer printouts, microfilm, microfiche, imaging, or other types of electronic media storage that can be readily reproduced into hard copies. These guidelines should be applied as well to the maintenance of ESA records.

Financial organizations that store records electronically should seek competent tax or legal advice to determine whether hard copy documents must be retained.

Length of Time to Keep RecordsFederal laws and agencies that govern financial organizations provide varying requirements and recommendations for retaining financial records. States also have laws that touch financial record retention requirements, which may be more stringent than the federal requirements. Conservatively, financial organizations should retain their records for seven or more years after the last activity has occurred (e.g., ESA is closed, last report is filed), but financial organizations should consult with their legal counsel if they choose to retain records for a different period.




IRS Information ReturnsIn IRS Publication 1220, Specifications for Electronic Filing of Forms 1097, 1098, 1099, 3921, 3922, 5498, and W-2G, the IRS states that payers should retain copies of information returns or have the ability to reconstruct the data for at least three years from the reporting due date. Depending on a financial organization’s policies and recordkeeping systems, copies of certain information returns, like Forms 1099-Q and 5498-ESA, might be necessary to reconstruct ESA transactions. Financial organizations conservatively may choose to keep these records for as long as they keep all other ESA records.

PenaltiesThe penalties for failing to properly retain records fall into two categories: civil and criminal. If any domestic financial organization and/or any partner, director, officer, or employee thereof willfully violates any of these recordkeeping requirements, the Secretary of the Treasury may assess a civil penalty. If the violation is deemed to be a result of negligence (rather than a willful violation), a civil penalty may be assessed. Any person willfully violating these recordkeeping requirements may be arraigned in a criminal court, and if convicted may be imprisoned and/or fined.

Compliance Check

ESA administrators should begin ascertaining internal ESA compliance by reviewing all the areas of compliance. Once an ESA administrator understands ESA requirements, the next step is to survey the organization’s ESA forms and operations. Financial organizations should evaluate any areas of noncompliance and determine how the situation may be remedied.

The following survey and log sheet will aid financial organizations in their ESA compliance program review. Financial organizations should gather a sampling of client files to examine and determine if proper procedures were followed. The “Individual Compliance Survey” may prove useful when examining individual client files. The “Coverdell ESA Forms Log Sheet” may be useful for financial organizations to track and assess the forms that currently are used by the organization. Because the passage of laws and release of governmental guidance may require changes to procedures, financial organizations should be sure that they are using the most recent versions available.





Individual Compliance Survey


Account or file number_________________________________ Date ESA established ________________________

Designated beneficiary name_________________________________ Date of birth __________________________

Address _________________________________________________________________________________________

________________________________________________________________________________________________

Responsible individual name_________________________________ Date of birth __________________________

Address _________________________________________________________________________________________

________________________________________________________________________________________________

Opening Documents

PLAN AGREEMENT

Signed/dated (or acknowledgment signed and dated)

By grantor/depositor Yes No

By responsible individual Yes No

By organization Yes No

Revision date

IRS Form 5305-E/5305-EA Date _______________

Forms provider form Date _______________

Was plan agreement the most current at opening? Yes No

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

DISCLOSURE STATEMENT





Source:

Publication 970 Revision date _______________

Forms provider document Revision date _______________

Other __________________ Revision date _______________

Was disclosure statement the most current at opening? Yes No


Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

INVESTMENTS

Investment selection of form _______________________

Properly registered Yes No

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

Contributions

REGULAR Not applicable

Contribution form

Signed/dated by contributor Yes No

Investment selected and properly registered Yes No

TRANSFER Not applicable

Transfer request form

Signed/dated by responsible individual Yes No

Contribution form Yes No


Copy of check in file Yes No


ROLLOVER Not applicable

Eligibility form






REPORTING

Form 5498-ESA matches contribution form Yes No NA


Distributions

DISTRIBUTION TO DESIGNATED BENEFICIARY Not applicable

Withdrawal form _________________________________________________________________________


Distribution reason provided Yes No

Form 1099-Q matches withdrawal form Yes No NA

DISTRIBUTION TO DESIGNATED BENEFICIARY’S ESTATE Not applicable

Certified copy of death certificate Yes No

Withdrawal form Yes No

Signed/dated by executor/executrix of estate Yes No

Distribution paid to designated beneficiary’s estate Yes No

Form 1099-Q in name and tax identification number of estate with distribution code 5 (if applicable) Yes No

DISTRIBUTION TO DEATH BENEFICIARY Not applicable


Valid death beneficiary designation form Yes No


Signed/dated by death beneficiary Yes No

Form 1099-Q in name and tax identification number of death beneficiary with distribution code 5 (if applicable) Yes No


Coverdell ESA Forms Log Sheet


Completed by____________________________________________________ Date __________________________

Forms provider ______________________________________________ Telephone __________________________

ESA Forms

Form used:

Number______________ Name _______________________________________________________________

Date started using _______________________________ Date obsolete _____________________________

Reason for discontinuance ___________________________________________________________________

Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________


Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________


Glossary of Termsadjusted gross income (AGI). AGI is determined by adding all sources of income, such as wages and interest income, and subtracting certain deductions and adjustments to income. It is also the starting point for determining eligibility for certain types of itemized deductions.

American Opportunity credit. The American Recovery and Reinvestment Act of 2009 created the American Opportunity tax credit for certain higher education expenses as a temporary replacement of the Hope Scholarship credit. The American Opportunity credit was made permanent by the Consolidated Appropriations Act of 2016.

code. See “Internal Revenue Code.”

custodian. The custodian is a bank or savings and loan association, as defined in IRC Section 408(n), or any person who has the approval of the IRS to act as custodian. Any person who may serve as a custodian of an IRA may serve as a custodian of an ESA.

death beneficiary. A death beneficiary is an individual or entity identified to receive ESA assets following the death of the designated beneficiary.

depositor. The depositor is the person who establishes the ESA custodial account.

designated beneficiary. A designated beneficiary of an ESA is the person on whose behalf the ESA has been established.

disclosure statement. The disclosure statement explains in simple, nontechnical language the rules that govern an ESA. Disclosure statements are optional for ESAs.

eligible educational institution. An eligible educational institution is any college, university, vocational school, or other postsecondary educational institution eligible to participate in student aid programs administered by the Department of Education. Eligible educational institutions also include public, private, or religious schools that provide elementary or secondary education as determined under state law.

excess contribution. An excess contribution to an ESA is the amount that exceeds the allowable limit for a designated beneficiary for a given tax year. If an excess contribution is not properly corrected, a six percent penalty tax applies.

fair market value. The fair market value is the value of an ESA as of a certain date.

financial disclosure. Financial organizations must provide certain financial disclosures to all persons who establish IRAs. Financial disclosures are not required for ESAs.

grantor. The grantor is the person who establishes the ESA trust.

individual retirement arrangement (IRA). An IRA is an individual retirement account or an individual retirement annuity. An IR account or annuity may be either a Traditional, Roth, or SIMPLE IRA.

Internal Revenue Code. Internal Revenue Code of 1986, as amended, contains the basic federal tax law.

IRS. The Internal Revenue Service is an agency of the Treasury Department, which is headed by the Commissioner of Internal Revenue. The IRS interprets and enforces the tax laws.

Glossary of Terms • 87

Lifetime Learning credit. A Lifetime Learning credit is a tax credit that may be claimed by an eligible student or parent of an eligible student for qualified tuition and related expenses.

modified adjusted gross income (MAGI). MAGI is used to determine eligibility to contribute to an ESA. MAGI used to determine eligibility of a grantor/depositor to make an ESA contribution is defined as AGI as shown on the grantor/depositor income tax return modified by adding back in foreign earned income exclusion, foreign housing exclusion or deduction, exclusion of income for bona fide residents of American Samoa, and exclusion of income for bona fide residents of Puerto Rico.

net income attributable (NIA). Net income attributable is the amount of income earned by an excess contribution to an ESA.

nondeductible contribution. A nondeductible contribution is a contribution that is made with after-tax dollars and is ineligible for an income tax deduction. All ESA contributions are nondeductible.

nonqualified distribution. An ESA distribution is nonqualified if the distribution amount exceeds the qualified educational expenses in a given year. The portion of the nonqualified distribution that represents earnings is taxed and generally subject to an additional 10 percent penalty tax.

plan agreement. The plan agreement explains the terms and conditions of the ESA and is the controlling contract. The plan agreement, along with other required documents, creates an ESA.

prohibited transaction. A prohibited transaction is an action in reference to an ESA that is forbidden under the law. These actions include taking a loan from the ESA, pledging or assigning the ESA as security for a debt, investing ESA assets in life insurance, etc.

qualified distribution. An ESA distribution is a qualified distribution if it is equal to the designated beneficiary’s qualified higher education expenses and qualified elementary and secondary education expenses at an eligible educational institution.

qualified educational expense. Qualified educational expenses include expenses for tuition, fees, books, supplies, and equipment at an eligible educational institution, as well as computer technology and related expenses. Room and board also generally is considered a qualified educational expense for students enrolled at least half time.

qualified tuition program. Qualified tuition programs, which are established and maintained by certain states, agencies, and eligible educational institutions, allow individuals to purchase credits or certificates, or to make contributions to an account that are to be used to pay for future qualified higher education expenses of a designated beneficiary. Effective for distributions taken after December 31, 2017, individuals may also use 529 plan assets (up to $10,000 per year per beneficiary) to pay for elementary and secondary school tuition expenses.

responsible individual. A responsible individual of an ESA, usually the parent or guardian of the designated beneficiary, is the person who redirects the initial investment and directs the investment of all additional contributions. In addition, the responsible individual directs the financial organization regarding administration, management, and distributions of the account.

rollover. A rollover is a tax-free, reportable movement of cash or assets from one ESA to another.

Roth IRA. The Roth IRA, created by the enactment of TRA-97, is a type of IRA available since 1998, that can only receive nondeductible contributions. A Roth IRA owner may be entitled to tax- and penalty-free distributions, provided certain rules are met.

88 • Glossary of Terms

Traditional IRA. The Traditional IRA is an IRA that can receive both deductible and nondeductible contributions. The earnings in a Traditional IRA are tax deferred. A distribution of assets from a Traditional IRA generally is taxable.

transfer. A transfer is a direct movement of assets between two ESAs. A transfer generally is from one organization to another organization, but may be between two ESAs at the same financial organization.

transmittal form. A transmittal form is a report summarizing how many forms are being submitted to the IRS. For example, IRS Transmittal Form 1096, Annual Summary and Transmittal of U.S. Information Returns, summarizes how many paper Forms 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530), are being transmitted.

trustee. A trustee is a bank or savings and loan association, as defined in IRC Section 408(n), or any person who has the approval of the IRS to act as trustee. Any person who may serve as a trustee of a Traditional IRA may serve as the trustee of an ESA.

withholding. Withholding is the prepayment of income taxes at the time of distribution from an IRA. Federal income tax withholding is not required for ESA distributions.

Glossary of Terms • 89

90 • Glossary of Terms

Coverdell ESA Opening Documents Log Sheet




Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________



Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Successor responsible individual name _______________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Plan Agreement/Application


Organization requires: Form 5305-E

Form 5305-EA

Forms provider document

________________________________________________________________

________________________________________________________________

Signatures: Grantor/depositor Yes No

Responsible individual Yes No

Organization Yes No


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________

The responsible individual may change the designated beneficiary. Yes No

The responsible individual will continue to serve as the responsible individual Yes Noafter the designated beneficiary attains the age of majority under state law.

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________





Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________




Signature: Yes No


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Contribution and Investment



Signature: Yes No


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Death Beneficiary Designation



Signature: Yes No


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________


Explain: ____________________________________________________________

___________________________________________________________________

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Signature

Employer signature ___________________________________________________ Date_________________

Coverdell ESA Contribution Log Sheet




Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Contributor name ________________________________________________________________________________


Address _________________________________________________________________________________________

________________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Contribution Type

REGULAR CONTRIBUTION Yes No NA

Date _________________ Amount of contribution _______________________




___________________________________________________

___________________________________________________

___________________________________________________





Explain: ____________________________________________________________


Explain: ____________________________________________________________

Copy to contributor: Yes No

Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________

ROLLOVER CONTRIBUTION Yes No NA





___________________________________________________

___________________________________________________

___________________________________________________





Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________

TRANSFER CONTRIBUTION Yes No NA





___________________________________________________

___________________________________________________

___________________________________________________





Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________

Signature

Employee signature ___________________________________________________ Date_________________

Coverdell ESA Investment Log Sheet




Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Initial Contribution Investment Selection


Contributor: Grantor/depositor



___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Investment selected by: Grantor/depositor


Investment selected: Investment description ________

___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Date selected _______________________



Yes Date sent ______________________

No Explain: ____________________________________________________

___________________________________________________________

Additional Contribution Investment Selection

Ongoing investment direction instructions from the responsible individual for additional contributions (if applicable)

________________________________________________________________________________________________

________________________________________________________________________________________________

________________________________________________________________________________________________

________________________________________________________________________________________________


Contributor: Responsible individual


___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Responsible individual contacted to make investment selection:

Yes Date contacted ______________________

No Explain: ____________________________________________________

___________________________________________________________

Investment selected: Investment description _______________________________________________

___________________________________________________________________

___________________________________________________________________

___________________________________________________________________

Date selected _______________________



Yes Date sent ______________________

No Explain: ____________________________________________________

___________________________________________________________

Coverdell ESA Distribution Log Sheet




Address _________________________________________________________________________________________


Address _________________________________________________________________________________________

Telephone _______________________________________________________________________________________

Distribution Type

DISTRIBUTION Type of distribution: Normal

Excess withdrawn in same year deposited

Excess withdrawn in year after deposited

Disability

Prohibited transaction



Signed/dated by responsible individual: Yes No

Explain: ____________________________________________________________

Copy to designated beneficiary: Yes No

Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________

DEATH BENEFICIARY Death beneficiary name ______________________________________________

Date of birth____________ Social Security number _______________________

Address ____________________________________________________________

Distribution requested: Yes No NA


Qualified family member assumes as own: Yes No

Date_________________ Amount _____________________________________


Withdrawal taken in year of death: Yes No

Type of beneficiary:

Qualified family member

Estate

Other ___________________________________________________________

Distribution requested and signed/dated by death beneficiary:

Yes No

Explain: ____________________________________________________________

Distribution requested and signed/dated by responsible individual:

Yes No

Explain: ____________________________________________________________

Copy to death beneficiary: Yes No

Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________


Explain: ____________________________________________________________

2021 Coverdell ESA Reporting Activity Log Sheet


Reporting year ___________________________________________________________________________________

Form 1099-Q


Due to IRS: February 28, 2022 March 31, 2022

Date sent: ______________________ ______________________



Form 5498-ESA


Due to IRS: May 31, 2022 May 31, 2022

Date sent: ______________________ ______________________

Due to designated beneficiaries: April 30, 2022 Date sent ______________________


Year-End Statement (optional)


Format ____________________________________


Form: 1099-Q 5498-ESA



To designated beneficiary: Name: ___________________________________ Date sent_______________

To responsible individual: Name: ___________________________________ Date sent_______________

Explain: ___________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Reporting Corrections (continued)

Form: 1099-Q 5498-ESA





Explain: ___________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Form: 1099-Q 5498-ESA





Explain: ___________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Form: 1099-Q 5498-ESA





Explain: ___________________________________________________________________________________

__________________________________________________________________________________________

__________________________________________________________________________________________

Signature

Employee signature ____________________________________________ Date _______________________

Individual Compliance Survey


Account or file number_________________________________ Date ESA established ________________________

Designated beneficiary name_________________________________ Date of birth __________________________

Address _________________________________________________________________________________________

________________________________________________________________________________________________

Responsible individual name_________________________________ Date of birth __________________________

Address _________________________________________________________________________________________

________________________________________________________________________________________________

Opening Documents

PLAN AGREEMENT





Revision date

IRS Form 5305-E/5305-EA Date _______________

Forms provider form Date _______________

Was plan agreement the most current at opening? Yes No

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

DISCLOSURE STATEMENT





Source:

Publication 970 Revision date _______________

Forms provider document Revision date _______________

Other __________________ Revision date _______________

Was disclosure statement the most current at opening? Yes No

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

INVESTMENTS

Investment selection of form _______________________

Properly registered Yes No

Notes: ____________________________________________________________________________________

__________________________________________________________________________________________

Contributions

REGULAR Not applicable

Contribution form

Signed/dated by contributor Yes No


TRANSFER Not applicable

Transfer request form






ROLLOVER Not applicable

Eligibility form






REPORTING

Form 5498-ESA matches contribution form Yes No NA

Distributions

DISTRIBUTION TO DESIGNATED BENEFICIARY Not applicable

Withdrawal form _________________________________________________________________________


Distribution reason provided Yes No

Form 1099-Q matches withdrawal form Yes No NA

DISTRIBUTION TO DESIGNATED BENEFICIARY’S ESTATE Not applicable



Signed/dated by executor/executrix of estate Yes No

Distribution paid to designated beneficiary’s estate Yes No

Form 1099-Q in name and tax identification number of estate with distribution code 5 (if applicable) Yes No

DISTRIBUTION TO DEATH BENEFICIARY Not applicable


Valid death beneficiary designation form Yes No


Signed/dated by death beneficiary Yes No

Form 1099-Q in name and tax identification number of death beneficiary with distribution code 5 (if applicable) Yes No

Coverdell ESA Forms Log Sheet


Completed by____________________________________________________ Date __________________________

Forms provider ______________________________________________ Telephone __________________________

ESA Forms

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

Form used:

Number______________ Name _______________________________________________________________



Form replaced by:

Number______________ Name _______________________________________________________________

Effective __________________________________________________________________________________

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