Final semester 529 plan withdrawal mistake creates tax liability for Dad

[daddibank]

I withdrew my son’s tuition costs ($6500) from a 529 plan on Jan 4th so that I could make sure the funds arrived at the Bursar’s office on time. Therefore, I will receive the 1099-Q in my name. This would not be a problem if my son had gone on to Graduate school as I had believed that he planned. However, he will graduate next month (May) and plans to go to work, thereby will no longer fit the IRS description of a dependent. I think that this will cause all the $6500 to be included with my taxable income, plus a $650 penalty. Is there any way to at least avoid the penalty? Obviously if I had had the 529 plan send the funds directly to the school this problem would not have arisen. But since I had it electronically transferred directly to my bank Is there any way to at least avoid the penalty?

[dcandmc]

I don't understand your concern. Did you take a distribution from the 529 account in January this year that was used to pay a qualified expense (tuition) for your son this year? If that's the case, it doesn't matter that the distribution was sent directly to your bank; it's not taxable income for either you or your son, even if you can't claim your son as a tax dependent this year. And if for some reason it's not considered a qualified distribution, only the earnings portion of the distribution, not the whole amount, would be subject to tax and the 10% penalty, if no penalty exception applies.