Any excess contributions that remain in the Coverdell ESA at the end of the year are subject to a 6% excise tax, that must be paid by the beneficiary. Excess contributions are defined as the total of:
Contributions to a beneficiary’s Coverdell ESA in excess of $2,000 for the year, or if the individual contributor’s limits are less, as described above, the excess over the total of their individual contribution limits. (But in any case, the total of different person’s individual contributions cannot be more than $2,000 for the year.)
Excess contributions from the previous year, less the total of:
distributions from the account during the year, and
any amount that could have been contributed this year, but was not.
The 6% excise tax does not apply on excess contributions made during the current year if the excess, and any earnings on the excess, is distributed by June 1 of the following year (or the first day of the sixth month of the following year, if taxes are reported on a fiscal year basis). But in this case, the portion of the distribution that represents earnings would have to be included in the taxable income of the person who made the excess contributions, in the year they were made. If excess contributions were distributed, you should receive Form 1099-Q, Payments from Qualified Education Programs (Under Sections 529 and 530), from the institution that distributed the excess contributions. These earnings would be reported as “Other Income” on Form 1040.
Example
If contributions of $2,400 were made to a beneficiary’s Coverdell ESA in year 1, and the excess of $400 was not distributed by June 1 of year 2, the beneficiary would owe a tax of $24 for year 1 ($400 times 6%).
If contributions of $2,500 were made in year 2, but the beneficiary withdrew $300 to pay qualified education expenses, the excess at the end of year 2 would be:
$400 excess from year 1
plus $500 excess from year 2
minus $300 withdrawal in year 2
equals $600 excess contribution at the end of year 2. An excise tax of $36 would be owed for year 2 ($600 times 6%).
If contributions in year 3 are limited to $1,400 ($2,000 minus $600 excess balance) no excise tax will be owed at the end of year 3.
If the excise tax is owed, it is calculated and reported in Part V of Form 5329, Additional Taxes on Qualified Plans (Including IRAs) and Other Tax-Favored Accounts.