New Turbotax user question: Entering a 1099-Q on Turbotax- taxable scholarship withdrawal

Question

Hello Turbotax community

I have a son in college. We are fortunate in that he received $22,000 in scholarships from his college. I withdrew $22,000 from his 529 plan, along with $1,889 in qualified educational expenses in 2022. This is a mostly taxable event as I owe money on the earnings associated with the scholarship withdrawal, but I am exempt from the 10% penalty for the scholarship withdrawals. I owe no tax on the $1,889 in qualified educational expenses withdrawals.

I received two 1099-Qs named as the recipient. One for $11,000 with the associated gross distribution, earnings, and basis boxes filled. This was for one scholarship withdrawal. The second 1099-Q was for $12,889 with the same boxes filled. This was a $11,000 scholarship withdrawal and the $1,889 in aforementioned qualified educational expenses.

QUESTION: I started entering the first 1099-Q with the $11,000 gross distribution and associated earnings and basis in the Federal Taxes>Deductions and Credits>Education>ESA and 529 qualified tuition program (Form 1099-Q) section. After I entered it, there was no change in Federal tax owed (it should have gone up). Further, I don't see the appropriate entries on any tax forms. I didn't enter the second one yet ($12,889 distribution) because something is not right with this first 1099-Q entry. How do I enter these 1099-Qs into Turbotax and designate $22,000 of the $23,889 in total 529 distributions as taxable, 10% penalty free scholarship withdrawals?

Thanks for your time in advance.

Hal_Al · Accepted Answer

Your qualified educational expenses (QEE) are $46,763 + 12,000 + 1889 = 60,652 .

60, 652 -22,000 scholarship = 38,652 Adjusted QEE

Your total 529 Plan distributions are $11,000 +12,889 + 23,044 = 46,933

$46,933 - 38,652 = $8281 shortfall in QEE

Assign that to the 1099-Q with the lowest percentage earnings. 8281/12,889 = 64.24% of earnings are taxable. 0.6424 x 5021 = $3225 Reportable earnings income

The alternative is to have the student report $8281 of his scholarship as taxable income, freeing up all the expenses for the 1099-Qs. Why is reporting $8281 income better than reporting $3225?? It's not just because it's gong on the student's return, instead of the higher tax rate parent's. We had that option already (but with $4938 taxable earnings rather than 3225).

Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $12,950 filing requirement and the dependent standard deduction calculation (earned income + $400). It is not earned income for the kiddie tax and other purposes (EIC. IRA contributions). So, $8281 + $2000 DoorDash income is $10,281 and that's less than $12,950, so he will have no taxable income. The $2000 probably has to be reported as self employment income, so he does need to file. You want him to file, anyway, to document the reporting of the taxable scholarship.

So, how do you enter all this in TurboTax. Quite easily. First and foremost, do not enter any 1099-Qs, on either your return or the student's. As explained in the earlier posts, they are not required* and entering them gets messy.

On the student's return, enter a 1098-T with box 1 blank and $8281 in box 5**. Enter no other numbers. Be sure the $8281 shows up on line 8r of Schedule 1, on his tax forms

*Reference: 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."

**The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return. However receipt of a 1098-T frequently means you are either eligible for a tuition credit or possibly your student has taxable scholarship income. You claim the tuition credit, or report scholarship income, based on your own financial records, not the 1098-T. Just change the numbers in boxes 1& 5 to what your records show. The 1098-T that you enter in TT is not sent to the IRS.

Hal_Al · Answer

Q. How do I enter these 1099-Qs into Turbotax (TT) and designate $22,000 of the $23,889 in total 529 distributions as taxable, 10% penalty free scholarship withdrawals?

A. TT is allocating some of the tuition to the education credit (probably $10K). On the Student Information Worksheet (abbreviated Student Info Wk on the forms list), go to part VI and change line 17 (“Used for credit”) to 0. Make the change in the first column. That will automatically change the other columns.

There are three things you can do with your Qualified educational expenses (QEE):

Allocate then to scholarships (so that the scholarship remains tax free)
Use them to claim an education credit
Allocate them to the 529 distribution (1099-Q) so that it will not all be taxable

TurboTax allocates QEE, in that order, but it doesn't do a very good job. It's best if you have some idea of the outcome expected, when you make your entries. It's not the $22,000 that is taxable. It's 92% (22000 / 23889 = 0.92) of the box 2 (earnings ) that is taxable. See example below.

You are allowed to allocate your expenses for the best tax advantage. Claiming the credit first is usually best. Having the student declare some of their scholarship taxable is usually better than paying tax on all the 529 earnings distribution.

__________________________________________________________________________________________

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 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 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 (on the recipient’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

There 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.