529 withdrawal against scholarship money

Forum|Forum|5 years ago
April 16, 2021
2 replies
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My situation is unique - some semesters I pay the college expenses from a 529, other semesters my ex husband pays from his 529. I do the student's taxes and claim her as a dependent.

This past year for all of 2020, he paid the college costs from his 529. She received a good amount of scholarship money, only $2000 was for dorm room, so I'm reporting that as taxable to her. Total scholarship was $28,000 (including the $2000). Since I excess funds in the 529, I withdrew 10K from the 529, against her scholarship amount. Of that 10K, $5100 was earnings/appreciation, which I am trying to report as taxable to her. It won't be subject to the 10% penalty since she received scholarship money and the 529 withdrawal is against that.

So, here are my questions:

1. Should I not report the 1099-T figures?

2. Should I enter the $2000 as scholarship, in order for it to be taxable?

3. How do I enter the $5100 in 529 fund appreciation/earnings as taxable income from the 1099-Q? (This would entail changing the entries for the 1099-Q boxes, and not entering the amounts as they appear on the form.)

Hal_Al

Employee

Other than being short of qualified expenses, are you otherwise eligible for the American Opportunity credit?

Does you student have any other income other than the taxable scholarship? How much? What source?

Is her scholarship restricted? That is must it be designated for tuition and fees. Shifting more of her scholarship to be taxable may be an option, to free up expenses for the AOC and 529 distribution.

When you withdrew the $10K from the 529, who was the recipient of the 1099-Q (you or the student)? It's not optional who's return it goes on ("am trying to report as taxable to her").

What expenses is the ex using for his 529 withdrawal?

SallyRandallAuthor

Thank you for your replies. To answer the questions:

I am not eligible for the AOTC.

The scholarship is from the college (it's merit aid) and it nets against all the fees, most of which are tuition and school fees. The $2000 "residential" scholarship reduces her dorm fee, and was removed during the semester she went to school remotely from home and did not live in the dorm (and there were no dorm fees that semester either).

The student was the recipient of the 529 withdrawal and the 1099-Q was issued to her.

She has other income from a job (about $11,000) and about $2100 in long term capital gains.

The ex would be using all of the fees assessed by the college - tuition, room and board to the extent in 2020 there was room and board. Plus I imagine he's withdrawing from the 529 to cover books. I don't have any expenses to withdraw against, hence the reason for the withdrawal against scholarship money.

Hal_Al

Employee

Assuming the ex is using all available expenses, for his 1099-Q, and nothing is available for your 1099-Q; you need to use a workaround in TurboTax (TT). Further assuming you’re not eligible for the AOTC and assuming the 1099-Q goes on the student’s return:

Enter the 1099-Q first.

Enter the 1098-T with $26,000 in box 1 and $28,000 in box 5. TT will treat the $2000 difference as taxable, putting it on line 1 of form 1040 with the notation SCH.

Answer yes to the book expense question. That will give you the screen to enter $2000 as room and board.

When asked if the scholarship was used for room and board, answer NO. Making that $2000 taxable frees up the dorm $ to be used for the 1099-Q. That will make $4080 of the $5100 taxable. TT will put the $4080 on line 8 of Schedule 1. It will generate form 5329 to claim the scholarship penalty exception.

The $4080 is unearned income and will subject her to the "kiddie tax", where most of the unearned income is taxed at the parent's marginal tax rate.

SallyRandallAuthor

This is fascinating, this workaround.

One clarification, and I think I know the answer:

the ex would have paid the dorm expense from his 529, so I think I would not want to free up $2000 in dorm to be used for my 1099-Q - is that right?

Now, how will TT know what the "kiddie tax" is if I haven't yet filed my tax return?

Hal_Al

Employee

Q. The ex would have paid the dorm expense from his 529, so I think I would not want to free up $2000 in dorm to be used for my 1099-Q - is that right?

A. Yes. Don't enter anything at room & board expenses.

Q. Now, how will TT know what the "kiddie tax" is if I haven't yet filed my tax return?

A. The interview, on your daughter's return, will ask her to input the parent's info. It's best if you have at least prepared your return, at the time you prepare hers. But estimates, of your income, are usually close enough.