Let's consider the regulations for the American Opportunity Tax Credit concerning the timing of payments. They don't apply to 529 plan distributions, but they illustrate the IRS thinking on the topic.
Specifically, I've appended an excerpt of the regulations at 26 CFR 1.25A-5. First, notice how paragraph (1) refers to payments made "for an academic period beginning in the same taxable year as the payment is made." It is only because of paragraph (2), a paragraph for which there is no similar regulation in connection with 529 plan disbursements, that it allows payments made for expenses for an academic period that begins within the first three months of the following tax year.
Note also that paragraph (4) indicates that the treatment of payments made by a tuition installment plan depend on whether the plan manager is considered to be an agent of the taxpayer or an agent of the educational institution. If the plan manager is an agent of the taxpayer, then the date the plan pays the educational institution is what matters. if the plan manager is an agent of the institution, then the date the taxpayer pays the tuition installment plan matters. Thus, it is important to read the contract the taxpayer signed with the tuition installment plan. If the contract indicates that the tuition installment plan is acting as an agent of the taxpayer, as most do, then it matters when the plan pays the college, not when the taxpayer pays the plan. (With regard to agency, there are important implications with regard to non-dischargeability of education debt.)
Mark
26 CFR 1.25A-5(e) Timing rules—(1) In general. Except as provided in paragraph (e)(2) of this section, an education tax credit is allowed only for payments of qualified tuition and related expenses for an academic period beginning in the same taxable year as the year the payment is made. Except for certain individuals who do not use the cash receipts and disbursements method of accounting, qualified tuition and related expenses are treated as paid in the year in which the expenses are actually paid. See §1.461-1(a)(1).
(2) Prepayment rule—(i) In general. If qualified tuition and related expenses are paid during one taxable year for an academic period that begins during the first three months of the taxpayer's next taxable year (i.e., in January, February, or March of the next taxable year for calendar year taxpayers), an education tax credit is allowed with respect to the qualified tuition and related expenses only in the taxable year in which the expenses are paid.
(ii) Example. The following example illustrates the rule of this paragraph (e)(2). In the example, assume that all the requirements to claim an education tax credit are met. The example is as follows:
Example. In December 1998, Taxpayer A, a calendar year taxpayer, pays College Z $1,000 in qualified tuition and related expenses to attend classes during the 1999 Spring semester, which begins in January 1999. Taxpayer A may claim an education tax credit only in 1998 for payments made in 1998 for the 1999 Spring semester.
(3) Expenses paid with loan proceeds. An education tax credit may be claimed for qualified tuition and related expenses paid with the proceeds of a loan only in the taxable year in which the expenses are paid, and may not be claimed in the taxable year in which the loan is repaid. Loan proceeds disbursed directly to an eligible educational institution will be treated as paid on the date the institution credits the proceeds to the student's account. For example, in the case of any loan issued or guaranteed as part of a Federal student loan program under title IV of the Higher Education Act of 1965, loan proceeds will be treated as paid on the date of disbursement (as defined in 34 CFR 668.164(a), revised as of July 1, 2002) by the eligible educational institution. If a taxpayer does not know the date the institution credits the student's account, the taxpayer must treat the qualified tuition and related expenses as paid on the last date for payment prescribed by the institution.
(4) Expenses paid through third party installment payment plans—(i) In general. A taxpayer, an eligible educational institution, and a third party installment payment company may enter into an agreement in which the company agrees to collect installment payments of qualified tuition and related expenses from the taxpayer and to remit the installment payments to the institution. If the third party installment payment company is the taxpayer's agent for purposes of paying qualified tuition and related expenses to the eligible educational institution, the taxpayer is treated as paying the qualified expenses on the date the company pays the institution. However, if the third party installment payment company is the eligible educational institution's agent for purposes of collecting payments of qualified tuition and related expenses from the taxpayer, the taxpayer is treated as paying the qualified expenses on the date the taxpayer pays the company.
(ii) Example. The following example illustrates the rule of this paragraph (e)(4). The example is as follows:
Example. Student A, Company B, and College C enter into a written agreement in which Student A agrees to pay the tuition required to attend College C in 10 equal monthly installments to Company B. Under the written agreement, Student A is not relieved of her obligation to pay College C until Company B remits the payments to College C. Under the written agreement, Company B agrees to disburse the monthly installment payments to College C within 30 days of receipt. Because Company B acts as Student A's agent for purposes of paying qualified expenses to College C, Student A is treated as paying qualified expenses on the date Company B disburses payments to College C.
