Mary Lou took an $8,000 distribution from her educational savings account and used $6,000 to pay for qualified higher education expenses. The remaining balance of $2,000 was used to purchase clothes. On the date of the distribution, her educational savings account had a $25,000 balance including the $20,000 she had contributed. How much of the $8,000 distribution is tax-free?

Question

Quizplus · Accepted Answer

The amount of the distribution that is tax-free is equal to the amount of qualified higher education expenses or the proportion of the distribution spent on qualified expenses. In this case, $6,000 of the $8,000 distribution was spent on qualified higher education expenses, so $6,000 of the distribution is tax-free. However, any portion of the remaining $2,000 that was not spent on qualified expenses is subject to taxes and penalties.

To calculate the taxable portion of the distribution, we can use the following formula:
Taxable amount = (Non-qualified expenses / Distribution) x Earnings

Since we know that Mary Lou's educational savings account had a $25,000 balance on the date of the distribution and she contributed $20,000, we can assume that the remaining $5,000 is earnings.

Using the formula above, we get:
Taxable amount = ($2,000 / $8,000) x $5,000 
Taxable amount = 0.25 x $5,000 
Taxable amount = $1,250

Therefore, the total amount of the distribution that is tax-free is $6,000, and the taxable portion is $1,250. The answer is C, $7,600.

Mary Lou Took an $8,000 Distribution from Her Educational Savings