529 withdrawal when scholarship is applied to the term bill

Forum|Forum|4 years ago
May 6, 2021
1 reply
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Hoping someone can guide me on 529 withdrawal. Here is the situation. My daughter's Spring term bill has these line items:

Tuition & fees = $16,000

Scholarship = $ 6,000

Amount Due = $10,000

I have 2 options.

Option 1: withdraw $10,000

Option 2: withdraw $16,000

I know that Option 1 has no tax implications.

My question is about Option 2. Do I need to pay tax on $6000 scholarship in Option 2, even though that money ($6000) is actually applied against the tuition & fees automatically by the university. My PA 529 GSP agent tells me that it is taxable. Is this right?

I thought that if the Scholarship is used for Qualified Education Expenses, it is not subject to taxes. Can someone clarify this?

Thanks.

Not A Product Question

Best answer by Hal_Al

Thanks, I guess, given the situation, there is no education credits she is eligible, right?

How do I play it this year 2022? Any advice?

Q. There is no education credits she is eligible for, right?

A. Simple answer: That's right, for 2021. If she had a tax liability, she could claim a non refundable credit, but that would require you to forego the $500 dependent credit.

Q. How do I play it this year 2022? Any advice?

A. You did it near perfectly in 2021. You withdrew the maximum amount without having to pay any tax. Theoretically, you coulda withdrawn another $5000, tax free, by having her declare about $5000 of scholarship as taxable income (it would not have actually been taxed). See my May 6, 2021 reply, above, for details.

AmyC

Employee

No, qualified expenses are not taxable income. I would absorb the extra $6,000 into room and board. You can take out more than $6,000. Room and board is higher than that, usually. Add books and supplies, etc it adds up.

See page 52 for qualified distributions at IRS Publication 970, Tax Benefits for Education.
Please see my 529 example with IRS information here.
See also Publication 970, Tax Benefits for Education.

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Hal_Al

Employee

Unless the scholarship is restricted; that is, it must be used for tuition, you have the option of how you allocate expenses. For most people, it is better for the student to pay tax on some of the scholarship, rather than making some of the 529 distribution taxable of forgoing the tuition credit. Up to $12,400 of scholarship can go untaxed depending on the student's other income.

As AmyC says, you need to factor in other items: room and board (even if student lives at home), books and computers.

Expanding your example:

Tuition & fees = $16,000

Scholarship = $ 6,000

Room and Board = $5000

Books and computer = $1000

Student had $6,200 wages from summer job

Declare $6000 scholarship taxable. Student has $12,200 taxable income (6000 + 6200). His standard deduction is $12,400*. He owes no tax.

Use $4000 of tuition to claim American Opportunity credit.

That leaves $18,000 ($16,000 + 5000 + 1000 - 4000} of expenses for the 529 distribution. You can withdraw $18,000 tax free.

You PA 529 GSP agent is essentially correct, scholarship CAN be taxable.

*Note: a dependent's standard deduction is $1100 or his earned income +$350, but not more than $12,400. For purposes of this calculation scholarship is treated as earned income.

tacopaAuthor

Related question. What will be the State (I live in Pennsylvania) tax impact on scholarship withdrawal? My daughter will be getting the reimbursement, while I am the account holder. As an account holder and contributor to 529, I deducted the contributions from State Tax (PA) years ago!!

I am not sure if PA taxes the entire amount or just the earnings. Anyone knows?