Dependent, 529 distribution, online school

[Margaret CPA in OH]

Client has 22 year old daughter who completed associate's degree from online school in 2008. School is accredited and recognized by US Dept. of Education. Daughter moved to client's rental building as resident caretaker and continued classes in 2009. Daughter earned $11,300. Client received final distribution from 529 plan of which daughter was beneficiary.

Is daughter a dependent of client or self? One could argue that she is self-supporting except for the FMV of the apartment, perhaps. Is the 529 money taxable? Client said she paid off daughter's car and daughter signed for $11,000+ loans for 2009 courses. I'm pretty sure client will say she gave the money to the daughter for qualified expenses and used 'other money' for the car, but don't know that for certain. Kind of a feeling, you know?

Daughter's living situation might be akin to off-campus housing but she has established her permanent, principal residence at the apartment. I don't know who benefits the most financially, probably client, but want to do the right thing regardless.

All opinions welcome!

[kcjenkins]

If she told you already that she used the money to pay off daughter's car, then it's taxable. But we all know that money is fungible, so if she changes her story to 'I used it to pay for courses in 09", then the question is, why did daughter have to borrow "$11,000+ loans for 2009 courses"? I think they blew it, whether she's a dependent or not.

[Margaret CPA in OH]

Curious, why do you state that 'they blew it?' Blew what?

The qualified expenses billed from one school were $5110 (Box 2) and payments received of $6541 from another (Box 1) so I rounded the $11,000 for loans. I am certain that they did not have that much cash but the 529 distribution was for $2735, just a dent.

Yes, I recognize the fluidity of the distribution but believe that the funds were applied to school costs whether directly or indirectly by freeing up car money for school expenses. I still have the question of dependency. And the distribution could be taxable but I still have the dependency question. Any clear direction there? I can see both sides of this argument as daughter lives rent free in client's property but is "on her own" sort of like the student that doesn't come home during summer break but stays at school to work.

Thanks for deeper insights!

[kcjenkins]

Reason I said 'they blew it' was based on your saying that Mom used the money to pay off her car. If you want to change that now, that's up to you, but I was reacting to the 'facts' as you posted them, Margaret.

As for the dependency, same thing. YOU SAID "Daughter moved to client's rental building as resident caretaker", which means she is paying for the rent through her services. So that is not Mom providing housing, that is property owner paying employee a fringe benefit. Which, by the way, while not taxable on the Fed return, CA considers it subject to state payroll taxes, I believe. Better check that.

[Margaret CPA in OH]

Fair enough, KC, about the distribution and I did raise the issue with the client. We will get it pinned down. I think if the distribution was made and daughter is not a dependent, it is then taxable to client but don't know that. I'm still trying to determine if daughter is a dependent.

The resident caretaker was my term because she does sweep the common areas, as I understand it, and lives there rent free, but I will confirm that, too. I will definitely investigate further as to the full extent of responsibilities or whether the arrangement is something else. This is a daughter, after all. The rental building is actually in an LLC owned by client and husband so that is a somewhat separate issue from whether she qualifies as a dependent based on the other 'facts' I posted.

I still don't have a good feel as to whether or not she would qualify as a dependent. Might it not be arguable that the client family is paying the rent by foregoing the income? Would this be significantly different from a family purchasing a condo for a college student child to live in while at school and maintaining the property? I think some number of parents do that, rent out the extra bedrooms but don't consider the resident child as an employee paying rent through services.

I wish dependency and at least a handful of other issues were much easier to determine!

Thanks again for your insights and comments. They really make me think about the whole picture more carefully.