Melissa took a $1,500 distribution from her educational savings account and used $1,200 to pay for qualified education expenses. Before the distribution, Melissa’s account balance was $4,000, of which $1,000 was earnings. Calculate the following:
a. The tax-free return of capital
b. Her new adjusted basis for her savings account
c. Distribution of earnings potentially subject to tax
d. The excludable portion of the earnings
e. The taxable portion of her earnings
What will be an ideal response?
a. $1,125. 75 percent of the account balance before the distribution was from Melissa’s contributions; therefore, 75 percent of the amount distributed is a return of her capital.
b. $1,875. $3,000 basis before distribution less tax-free return of capital of $1,125.
c. $375. The total distribution of $1,500 less the $1,125 return of capital.
d. $300. The potential amount subject to tax, $375, times the ratio of the amount used to pay for qualified education expenses, $1,200, to the full distribution, $1,500, equals the excludable portion.
e. $75. The potential amount subject to tax, $375, times the ratio of the amount not used to pay for qualified education expenses, $300, to the full distribution, $1,500, equals the taxable portion.
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