Is my logic correct......kid in college, 529 plan scholarship withdrawals

Question

TurboTax brain trust:My dependent Kid is in collegeKid has $6194 of 1040 line 11 income on his tax returnParents don't qualify for any Tax credits/deductions for college tuition due to income1098-T box 1 shows $54671$22,000 in scholarship money from collegetotal of parental 529 withdrawals = 53054 ($22,000 of which is scholarship withdrawal)22,000 scholarship withdrawal has $13428 basis  QFE= 54671 from 1098-TQualified Educational Expenses (QEE) = 54671-22000 = 32671QEE shortfall = 53054 total 529 withdrawals -32671 = 20383 Kid has 7256 of room left in his 1040 that I could add to his income and have it not be taxed(13850 std ded -6194 line 11 -400 = 7256) So of the $22,000 in scholarship income, I should assign to him $7256, leaving $14744 to assign to my tax return?  Also I'm confused should I be assigning gross scholarship 529 withdrawal or the taxable earnings portion?  The entire $22,000 amount won't be taxable because it has $13428 of basis.Thanks!

Hal_Al · Accepted Answer

I would like the extra $150 to the family and I don't mind it being a little more difficult if you don't mind guiding me along the way.

Thanks for your time.

Here’s the short cut entry method in TurboTax:

Enter his 1098-T with $0 in box 1 and $7256 in box 5. Do not enter any other amounts. That will put $7256 of taxable income on line 8r of his schedule 1.

Because we are going to make a designated amount of the student-recipient’s 1099-Q taxable, it’s best to use a workaround, rather than counting on TT to come up with the right answer.

Enter his 1099-Q. When asked who the student is answer: someone else not listed here (lying to TurboTax to get it to do what you want does not constitute lying to the IRS). Enter the student's name when asked. A few screens later, you'll get one simple screen to enter expenses. Press Done at the 1099-Q summary screen, to get there. Enter the amount of tuition as $23,827. Enter $3205 as the amount of tax-free assistance*. The last entry makes $3205 of the distribution unqualified but also applies the scholarship exception to the penalty.

On your return: Add the 1099-Q numbers together and make one 1099-Q entry (beware of rounding; box 2 + box 3 must equal box 1). When asked who the student is answer: someone else not listed here (lying to TurboTax to get it to do what you want does not constitute lying to the IRS). Enter the student's name when asked. A few screens later, you'll get one simple screen to enter expenses (don't enter anything in the education expenses section). Press Done at the 1099-Q summary screen, to get there.

For tuition enter $30844 (54671-23827). R&B $5850. Books $198. For tax free assistance, enter $11,539 (22,000-3205-7256= 11539)

* We want him to have $1250 of taxable income. The first $1250 of unearned income is taxed at the student’s marginal rate (10%). The earnings portion of the 1099-Q is 39% of the distribution (9271/23827=0.39). 39% of X = 1250. X=1250 / 0.39. X = 3205 (we are making $3205 of the distribution unqualified).

Hal_Al · Answer

Books and a computer are also  QEE.Room and board are also QEE, but only for the 529 distribution.  Q. So of the $22,000 in scholarship income, I should assign to him $7256, leaving $14744 to assign to my tax return? A. Yes, your math and logic are right.  It can get a little tricky in entering in TurboTax (TT). Reply back for workarounds if you don't get the anticipated results.  But, first dig up your R&B, books and computer expenses.  If he lives off campus, R&B are limited to the lesser of your actual cost or  the schools allowance for attendance (usually the school's R&B on campus charge). If he lives at home, the school’s R&B “allowance for cost of attendance” for student living with parents Q. Also I'm confused should I be assigning gross scholarship 529 withdrawal or the taxable earnings portion?  The entire $22,000 amount won't be taxable because it has $13428 of basis.A. Basically, "it doesn't work like that".  In your TT interview you will enter $14744 as the amount of (tax free) scholarship the student received.  See sample calculation below (in red). ____________________________________________________________________________________________Qualified Tuition Plans  (QTP 529 Plans) DistributionsGeneral DiscussionIt’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 American Opportunity Credit (AOC or AOTC) is 100% of the first $2000 of tuition and 25% of the next $2000 ($2500 maximum credit). 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 regardless of whose money was used to pay 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 which is only qualified for the 1099-Q)   -$3000 paid by tax free scholarship***   -$4000 used to claim the American Opportunity credit =$3000 Can be used against the 1099-Q (on the recipient’s return) Box 1 of the 1099-Q is $5000Box 2 is $28003000/5000=60% of the earnings are tax free; 40% are taxable40% x 2800= $1120There is  $1120 of taxable income (on the recipient’s return) **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. A student, with no other income, can have up to $13,850 of taxable scholarship (in 2023) and still pay no income tax.