A Coverdell Education Savings Account (ESA) allows taxpayers to establish custodial accounts using post-tax funds. Custodians do not pay income taxes while their accounts grow or earn interest but may pay income taxes upon distribution. Custodians cannot contribute more than $2,000 per year to any individual Coverdell ESA. Generally, the Internal Revenue Service does not tax distributions if they are used for qualified educational expenses. Beneficiaries of Coverdell accounts will pay income taxes if their distributions exceed their annual qualified educational expenses. If you are the beneficiary of a Coverdell ESA, you can find your annual earnings and Coverdell basis by reviewing your 1099-Q form. Your basis is the total amount of your Coverdell contributions minus the amount you withdraw that is not taxable.
Step 1
Review your IRS Form 1099-Q, Payments From Qualified Education Programs (Under Sections 529 and 530). Your bank is legally required to provide you with a copy of the form by Jan. 31, annually.
Step 2
Review Box 3. Box 3 is your basis. Your basis will determine your income tax liabilities each year.
Step 3
Review Box 1. Box 1 reflects the total amount of your annual gross Coverdell ESA distributions.
Step 4
Calculate your income tax liabilities. You will pay taxes on the total amount of your distributions that exceed your qualified educational expenses annually.
Step 5
Use IRS Worksheet 7-3, Coverdell ESA -- Taxable Distributions and Basis. You can find this worksheet at the end of Chapter 7 in IRS Publication 970 (2010), "Tax Benefits for Education." Using the worksheet can reduce the opportunities for making mathematical mistakes in calculating your basis or the difference between your contributions and your qualified tuition expenses.
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