Question

A distribution of $15,000 is taken from a Coverdell Education Savings Account in a given year, but only $13,000 is used for the beneficiary's qualified education expenses in that year. The tax consequence is:________.

A. $2,000 is taxable
B. $2,000 is taxable and a 10% penalty will be imposed
C. $15,000 is taxable
D. $15,000 is taxable and a 10% penalty will be imposed

Answer 1

B) $2,000 is taxable and a 10% penalty will be imposed

Step-by-step explanation:

Coverdell ESA distributions that are not used for qualifying educational expenses must be included in the gross income of the beneficiary and usually will be subject to a 10% tax penalty.

Coverdell ESA contributions are not taxed deductible, but the interest that they earn is not taxed. If the distributions are used to cover qualifying educational expenses, they are not taxed. But if they are not used properly, they must be included in the gross income of the beneficiary and will usually result in a 10% tax penalty (of the unused amount).