Advanced Underwriting Consultants

Ask the Experts – May 8

Ask the Experts!

The professionals at Advanced Underwriting Consultants (AUC) answer the tax and technical questions posed by producers.  Here’s the question of the day.

Question: My client started a Coverdell educational savings account (“Coverdell ESA”) for her daughter in 2013 and has made the maximum contribution of $2,000 towards it in both 2013 and 2014. My client’s parents (i.e. the daughter-beneficiary’s grandparents) also maintain a Coverdell ESA for the benefit of my client’s daughter, and they have contributed the maximum $2,000 to the plan since 2013 as well. Can both parties contribute the maximum?

Answer: No; while the contribution limit is $2,000 per year, this limit is based on the beneficiary—it’s not based on each ESA nor is it based on each person making a contribution. In other words, $2,000 is the yearly maximum that can be contributed towards all of an individual’s combined Coverdell ESAs.

As with excess IRA contributions, the penalty for excess Coverdell ESA contributions is 6% of the excess contribution per year, determined at the end of the year. This means your client’s daughter faces a $120 penalty (6% of $2,000 excess contribution) in 2013.

However, there is an important exception. The 6% excise tax does not apply if excess contributions made during 2013 (and their earnings) are distributed before the first day of the sixth month of the following tax year (June 1, 2014, for a calendar year taxpayer).

The daughter would still have to include the distributed earnings in gross income for the year in which the excess contribution was made (she should receive an IRS Form 1099-Q from the custodian). She would need to make a corrective distribution for 2014 as well.

Have a question for the professionals at AUC?  Feel welcome to submit it by email.  We may post your question and the answer as the question of the day.