My client, let’s call him Alfred Wiedersehen, has twin children who turned age 3 in 2007. Both attend a pricey preschool.
Alf had opened up a Coverdell Education Savings Account (ESA) for each of the children in 2004. In 2007 he took a distribution of $2,500 from each of the ESA accounts to help pay for the preschool costs. The trustee of the ESA accounts issued two Form 1099-Qs (Payments from Qualified Education Programs) to report the distributions.
While most tax benefits associated with education apply only to post-secondary education (i.e. college or other education that takes place after graduating from High School), with a Coverdell ESA qualified expenses can be “either higher education (post-secondary) expenses or elementary and secondary education expenses”. It can be used for “tuition for any public, private, or religious school that provides elementary or secondary education (kindergarten through grade 12), as determined under state law”. However, pre-elementary education expenses, such as the cost of “pre-school”, are not qualified expenses.
I asked my client who told him he could make a withdrawal from a Coverdell ESA to pay for preschool education. His answer was “I just ass u me-d it (emphasis on the last syllable)”. Those are his exact words, taken from his email response.
Once again we learn that, as Felix told Oscar on THE ODD COUPLE sitcom, when you “assume” you make an “ass” out of “u and me”! Actually in this case only you (the client) and not me.
The moral of the story – don’t assume! Before doing something that involves income taxes check with your tax professional.
What happenned in this case is that each of the children had to file a tax return and report taxable income from the Coverdell ESA. While they did not have to pay federal income tax because of the amounts involved they did have to pay a 10% premature withdrawal penalty on the taxable portion of the distribution.
It was not an expensive mistake, but the penalties and my fee for preparing the two returns represent unnecessary expenses that could have been avoided.