529 and distribution in lieu of scholarship. TT calcs don't seem to add up.

Question

If I understand it, the part of a 529 earnings distribution withdrawn that is in lieu of a scholarship received by my dependent son has to be claimed as income if it isn't used for educational expenses, but there is no penalty on it. I can't figure a way to make turbotax do this correctly. I've entered my 1099-T and 1099-Q related to this account but the numbers don't add up. It should be this simple:

1099-Q

Box 1: $13583

Box 2: $8006

1098-T

Box 1: $27166 (total received by college, including scholarships)

Box 6: $14000 (total scholarships received)

$7000 of 1099-Q Box 1's were distributed to me in lieu of scholarship

Amount to add to income should be:

Scholarship/Total Distribution = Scholarship ratio

Earnings attributed to scholarship = Earnings * Scholarship Ratio

7000/13583 = 0.515

Earnings Adjustment = 8006 * 0.515 = $4123

However, Turbotax only adds $2943 on line 8 schedule 1

It's interesting, when entering the 1099-R , Turbotax never asks me if all or part of the distribution was used to pay for tuition for my dependent.

Hal_Al · Accepted Answer

The whole distribution amount ($7235) is NOT taxable. What's taxable is a portion of the earnings ($4164 max). It's a matter of entering the off setting expenses.

Your situation is a little more complex than others I've seen. I'm actually working on your numbers now. I'll get back to you with specific instructions a little later.

$27,166 of qualified Tuition expenses

+ 2,800 Board

- 14,000 paid by tax free scholarship

= 15,966 of expenses are available for the 529 distribution

$13, 583 Parent's Box 1 1099-Q

+ 7, 235 Student's Box 1 1099-Q

$20,818 Total distribution

- 15,966

= 4852 Total Non Qualified distributions

You want at least ~$1500 (2200-775 +88 -19) to go on the student's return to take advantage of his lower tax rate. After that, it should be taxed at the parent’s rate regardless of which return it’s entered on*.

So, for simplicity, you should not enter your 1099-Q, at all, taking the attitude it’s all covered by qualified expenses. For your son’s return, he has 15, 966 – 13,583 = 2383 of qualified expenses and 7235 – 2383 = $4852 non-qualified distribution.

How to enter, in TT, on his return:

Enter the 1099-Q, exactly as received.

Enter the 1098-T with $16,383 (14,000 + 2383) in box 1 and $14,000 in box 5. The scholarship must be shown for TT to calculate the penalty exception. Enter no other numbers (board/meals was used by you).

Anticipated result: 4852/7235 =67% of the earnings are taxable. 0.67 x 4164 =2792 taxable income which will be entered on line 8 of Schedule 1.

*But, taxes are complicated and ideally you would try several scenarios to see which way comes out best. But that’s cumbersome in do-it-yourself software.

Hal_Al · Answer

@jeffschmitz

What does "in lieu of scholarship" mean? How did you come up with $7000?

Based on the numbers you stated, only a tiny portion of the 529 distribution would be taxable. If you add in room &board, books and computers, none of it will be taxable and you should even have enough left over to claim the tuition credit.

__________________________________________________________________________________________

Qualified Tuition Plans (QTP 529 Plans) Distributions

General Discussion

It’s complicated.

For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q.
The 1099-Q gets reported on the recipient's return.** The recipient's name & SS# will be on the 1099-Q.
Even though the 1099-Q is going on the student's return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because he is your dependent.

You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The educational expenses he claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit, that gets him an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. Another special rule allows you to claim the tuition credit even though it was "his" money that paid the tuition.
In addition, there is another rule that says the 10% penalty is waived if he was unable to cover the 529 plan withdrawal with educational expenses either because he got scholarships or the expenses were used (by him or the parents) to claim the credits. He'll have to pay tax on the earnings, at his lower tax rate (subject to the “kiddie tax”), but not the penalty.

Total qualified expenses (including room & board) less amounts paid by scholarship less amounts used to claim the Tuition credit equals the amount you can use to claim the earnings exclusion on the 1099-Q.
Example:
$10,000 in educational expenses(including room & board)

-$3000 paid by tax free scholarship***

-$4000 used to claim the American Opportunity credit

=$3000 Can be used against the 1099-Q (usually on the student’s return)

Box 1 of the 1099-Q is $5000

Box 2 is $600

3000/5000=60% of the earnings are tax free

60%x600= $360

You have $240 of taxable income (600-360)

**Alternatively; you can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip! When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.

On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution."

***Another alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit.