529 distribution and dependency question

Forum|Forum|5 years ago
March 1, 2021
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Hello:

I withdrew money from my daughter's 529 college account to ay her grad school tuition. Since I cannot claim her as my dependent in my tax return because she is over 26 years old, Turbo Tax makes the college account distribution taxable. Is this correct?

Hal_Al

Employee

Being 26 doesn't mean she can't be your dependent. It just means she can't be your "qualifying child".

There are two types of dependents, "Qualifying Children"(QC) and standard ("Qualifying Relative" in IRS parlance even though they don't have to actually be related). There is no income limit for a QC but there is an age limit and student status test, a relationship test and a residence test.

A person can still be a Qualifying relative dependent, if not a Qualifying Child, if he meets the 6 tests for claiming a dependent:

Closely Related OR live with the taxpayer ALL year
His/her gross taxable income for the year must be less than $4300 (2020).
The taxpayer must have provided more than 1/2 his support

In either case:

He must be a US citizen or resident of the US, Canada or Mexico
He must not file a joint return with his spouse or be claiming a dependent of his own
He must not be the qualifying child of another taxpayer

If you are the owner of the 529 plan, that money is considered as support from you, not her, even though she is the beneficiary.

The taxability of a 529 distribution has nothing to do with whether the beneficiary is a dependent. As long as the money was spent on the beneficiary's educational expenses, it is considered a qualified (tax free) distribution. When the beneficiary is not a dependent; you enter the expenses immediately after entering the 1099-Q (entering is easier than when she is a dependent.

Or better yet, just don't enter the 1098-Q, at all. 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.

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."

Hal_Al

Employee

Qualified Tuition Plans (QTP 529 Plans)

It’s complicated.

For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” ( the student ). 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 owner's return, the 1098-T should go on the student's return, so he can claim the education credit, if he is not a dependent.

There needs to be some coordination between the parent and the student, when the student is not a dependent. He can and should claim the tuition credit before the parent claims the 529 plan earnings exclusion. The educational expenses you claim for the 1099-Q should be reduced by the amount of educational expenses he claims for the credit.
Be aware, you can not double dip. He cannot count the same tuition money, for the tuition credit, that gets you an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is usually more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion.
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 you) to claim the credits. You'll have to pay tax on the earnings, 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 tuition credit

=$3000 Can be used against the 1099-Q

Box 1 of the 1099-Q is $5000

Box 2 is $600

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

60%x600= $360

The recipient has $240 of taxable income (600-360)

**Alternatively; you can just not report the 1099-Q, at all, if the 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.

***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.

DaveZeee

Hello,

I've been researching the 529 issue and find it confusing. If my funds were sent directly to the school, then my student/daughter is the "recipient" and the "beneficiary." What I'm not clear on is whether these funds count as support from the Parent or the Student? This matters in our case for determining whether she will file as a Dependent that her parents will claim or on her own. Thanks for any thoughts on this...