529 withdrawal for non educational expense because of scholarship

Forum|Forum|4 years ago
February 21, 2022
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My son has a full scholarship for his college expenses. I withdrew money from the 529 plan, where he is listed as beneficiary, for my own use. I understand that I will have to pay taxes on the earnings portion but should not be subject to the 10% penalty. How should I enter this in turbotax?

Best answer by Hal_Al

If you have decided that the entire amount (the earnings portion $5553) of the 1099-Q is taxable (and don't want to work on reducing the tax as described on my other reply; here's the short cut in TurboTax:

Enter the 1099-Q. Enter the 1098-T (20,000 in box 1 and at least 20,000 in box 5). Don't bother with any other numbers. For the result, verify that $5553 is shown on line 8z of Schedule 1 and that form 5329 is generated and shows no penalty.

Hal_Al

Employee

This actually get a little tricky in TurboTax (TT) and there may still be some expenses that can reduce how much is taxable.

Provide the following info for more specific help:

Are you the student or parent.
Is the student the parent's dependent.
Box 1 of the 1098-T
box 5 of the 1098-T
Any other scholarships not shown in box 5
Does box 5 include any of the 529/ESA plan payments (it should not)
Is any of the Scholarship restricted; i.e. it must be used for tuition
Box 1 of the 1099-Q
Box 2 of the 1098-Q
Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)?
Room & board paid. If student lives off campus, what is school's R&B charge. If the student lives at home, only the school's board charge for on campus students.
Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers
How much taxable income does the student have, from what sources
Are you trying to claim the tuition credit (are you eligible)?
Is the student an undergrad or grad student?

____________________________________________________________________________________

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 $2800

3000/5000=60% of the earnings are tax free; 40% are taxable

40% x 2800= $1120

You have $1120 of taxable income

**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. Most people come out better having the scholarship taxable before the 529 earnings.

drejohAuthor

I am the parent and owner of the 529. The student is my dependent son- a junior in college. We are not using any of the 529 plan for him (even though he is the designated beneficiary) because his scholarship covers more than his tuition, room and board. The student paid some tax (on his taxes) on the portion of the scholarship that went beyond tuition and room/board. Box 1 of his 1099-T lists approx 20,00. Box 5 lists 27000 (no other scholarships nor 529 money). Scholarship is not restricted. Box 1 of 1099Q is 15,000. Box 2 is 5,552.94 Parents name and social security number are on the 1099Q. Parent not eligible for tuition credit

My question is, since I (the parent and owner of the 529) withdrew money for other purposes (I the parent am the beneficiary listed on the 1099-Q) how do I (the parent) correctly enter in turbotax this withdrawal on my taxes so that I pay taxes on the earnings but NOT the penalty for withdrawing money for unqualified expenses (since my son's tuition and room and board are more than covered by his scholarship.)

JillS56

To report the 1099-Q on your tax return follow these steps:

Open or continue your return.
Select Federal and then Deductions & Credits.
Scroll down to the Education section under All tax breaks.
Select, Show more and select Start or Revisit next to ESA and 529 qualified tuition programs (Form 1099-Q).
Follow the screens to enter your info.

Entering 1099-Q

1099-Q

You may still incur a penalty on the withdrawal. The rules state if you don’t use your college savings plan for eligible expenses, your 529 plan nonqualified withdrawals may incur a 10 percent penalty and will also be subject to income taxes. That said, both the penalty and the taxes apply only to your gains in the account.

Hal_Al

Employee

In TurboTax (TT), you enter all the student's info and TT calculates the taxable amount, sees the scholarship and applies the penalty exception. It prepares form 5329 to document the penalty exception. That's how it's designed. Unfortunately, it doesn't always work well.

It's important that you enter the 1099-Q before you enter the 1098-T and other expenses. Answer yes when asked it you have book expenses. That will get you the room & board entry box, as well as books and computers. When you enter the scholarship amount (box 5 of the 1098-T), reduce the amount you enter by the amount the student paid tax on*. Even though you are not eligible for the tuition credit, TT may assign some of the expenses for the credit. In his interview, you may eventually reach a screen called "Amount used to calculate education deduction or credit" Be sure the amount in that box is 0.

* If the student has no other income, other than the scholarship, he should report $12,550 of it as taxable. That's his standard deduction, so he will pay no tax and free up about $5550 of expenses for you to use on the 1099-Q. You say the student paid some tax (on his taxes) on the portion of the scholarship that went beyond tuition and room/board (R&B). That's wrong. The part that pays R&B is not tax free. So, since he has to pay tax on it, you should claim the R&B to reduce the tax on the 1099-Q. If he has already filed, you should consider amending his return.