Early distribution recipients must use Form 1040 to report the taxable earnings – specifically on line 15b (or 16b on 1040NR). Form 5329 is then used to report how much
(if any at all) is subject to the 10% additional tax if you qualify for an exception for qualified higher education expenses. Form 5329 is available here:
www.irs.gov/pub/irs-pdf/f5329.pdf and the instructions are available here: www.irs.gov/pub/irs-pdf/f5329.pdf.

For your information, the first set of instructions from Form 5329 is as follows:

Who Must File
You must file Form 5329 if any of the following apply, except you do not have to file Form 5329 to report a qualified disaster recovery assistance
distribution.

• You received an early distribution from a Roth IRA, the amount on line 23 of Form 8606, Nondeductible IRAs, is more than zero, and you are required to enter
  an amount that is more than zero on Form 5329, line 1 (see Exception for Roth IRA Distributions on page 2).

• You received an early distribution subject to the tax on early
  distributions from a qualified retirement plan (other than a Roth IRA) and distribution code 1 is not shown in box 7 of Form 1099-R, Distributions From Pensions, Annuities,
  Retirement or Profit-Sharing Plans, IRAs, Insurance Contracts, etc. Note. You do not have to file Form 5329 if distribution code 1 is correctly shown in box 7 of all
  Forms 1099-R and you owe the additional tax on each Form 1099-R. Instead, see the instructions for Form 1040, line 58, or Form 1040NR, line 54, for how to report the
  additional 10% tax directly on that line.

• You meet an exception to the tax on early distributions and distribution code 1 is shown in box 7 of Form 1099-R.
• You meet an exception to the tax on early distributions from the list on page 3 but box 7 of your Form 1099-R does not indicate an exception or the exception does not apply to the
  entire distribution.

• You received taxable distributions from Coverdell ESAs or QTPs.
• The contributions for 2009 to your traditional IRAs, Roth IRAs, Coverdell ESAs,
  Archer MSAs, or HSAs exceed your maximum contribution limit, or you had a tax due from an excess contribution on line 17, 25, 33, 41, or 49 of your 2008 Form 5329.

• You did not receive the minimum required distribution from your qualified retirement plan. However, for 2009, you are not required to take a minimum distribution from your defined
  contribution plan or IRA. See Waiver of required minimum distributions for 2009 on page 6 for more information.

Source: www.irs.gov/pub/irs-pdf/i5329.pdf

Some other situations in which Form 5329 is required exist. For example, if other distributions occurred from an IRA or qualified retirement plan, or you made extra contributions to
tax favored accounts, then the IRS directs you to read the instructions on line 58 (Form 1040) or line 54 (Form 1040NR) to see if you need to file Form 5329.

Line 58, Form 1040:

Source:www.irs.gov/pub/irs-pdf/f1040.pdf

Source:Line 54 Form 1040NR:

www.irs.gov/pub/irs-pdf/f1040nr.pdf

• Veterans’ educational assistance
• Coverdell education savings account (ESA) the expenses used to calculate the tax-free portion of distributions
• Any employer sponsored educational rebates or assistance
• Pell Grants
• The tax-free part of scholarships and fellowships
• Any miscellaneous tax-free or nontaxable payments (not counting inheritance or counting gifts) received as educational assistance/support

It is important not to reduce the qualified educational expense calculation by amounts paid with funds the student gets in the following manner:

• Gifts or loans
• Payments such as wages or payment for other services
• Student’s inheritance or inheritance from the individual making the withdrawal
• Personal savings withdrawals or withdrawals from QTP Qualified Tuition Program savings

The good news is that if your IRA distribution is less than or equal to your adjusted qualified income expenses then you are not subject to the addition 10% tax.

Sample Case #1, Practice Calculation:
Let’s say Albert age 35 didn’t work for a year and attended school full-time to get an MBA. He paid $5,600.00 of qualified educational expenses from the following sources:

• Educational Assistance provided through an employer (tax-free) $4,900.00
• IRA early distribution $3,300.00

To calculate whether Albert has to pay the additional 10% tax on his IRA distribution, he must first reduce his total qualified educational expenses in the following manner:

• Total Qualified Educational Expense $5,600.00
• Subtract Educational Assistance provided through an employer (tax-free) $4,900.00
• Equals Adjusted Qualified Education Expenses (AQEE) $700.00

Since Albert’s AQEE ($700) is greater than the taxable portion of his IRA distribution, he does not have to pay the 10% additional tax on any part of the distribution. However he must be sure that he reports the $490 taxable earnings in his gross income that is subject to income tax.

Sample Case #2, Practice Calculation:
Using the same scenario as Sample Case #1, Practice Calculation, however, let’s assume that that Albert deducted some of the contributions to his IRA so the taxable part of his early distribution is $1,100.00. This must be included in his income subject to income tax because the taxable part of Albert’s early distribution is greater than his AQEE. So Albert must pay the 10% additional tax on $400.00. This is the taxable part of the distribution (41,100) that is more than his qualified educational expenses ($700.00). He does not have to pay the additional tax on the remaining $700.00 of the taxable distribution.

Next: What are the Non-taxable Distribution Amounts?

• Tuition
• Fees
• Books
• Supplies
• Equipment required for attending or enrolling in the institution
• Costs associated with special needs services for special needs students connected to enrollment at the school, university, college or institution.

What about room and board?
Room and board expenses qualify to the extent that it is not more than the greater of the following situations:

• Allowance: The allowance for the R&B, as decided by the qualified educational organization, that was included in the cost of attendance (for federal financial aid purposes) for a certain academic period and living arrangements of the scholar or student.
• Amount Charged: The amount charged if the student is living in housing owned or operated by the institution.

What is an eligible educational institution?
The IRS defines an eligible education institution as an organization eligible to participate in a student aid program administered by the U.S. Department of Education including:

• Colleges
• Univeristies
• Vocational schools / tech schools
• Postsecondary educational institute
• Note: there are some institutions outside the United States that are qualified for U.S. Department of Education student aid programs

If you are not sure, simply ask your school if they are qualified to accept student aid administered by the U.S. Department of Education.

Another way to check is to search the U.S. Department of Education Database of Accredited Postsecondary Institutions and Programs located here: http://ope.ed.gov/accreditation/Search.aspx

What about part time or half-time students?

The IRS says that room and board are qualified expenses for half time students. They define a half time student as someone is enrolled for exactly half the full-time academic workload for the field of education that the person is pursuing as determined by the standards of the school being attended.

Next: What are the Non-taxable Distribution Amounts?