TT should NOT apply 10% penalty on 529 distribution in the amount of my scholarship. How do I fix this without overriding?

Forum|Forum|5 years ago
February 15, 2021
2 replies
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Distributions from 529 plans in the amount of a scholarship are taxable but are NOT subject to the 10% non-qualified distribution penalty. If I override TT's calculation it won't let me e-file. How else can I correct this issue.

KrisD15

True, distributions taken but offset by scholarships are not subject to the penalty tax.

If the 1098-T is inputted before the 1099-Q, the TurboTax program might have a hard time with the 1099-Q.

Please review the education interview and re-answer the questions to get to the last "Maximize My Tax Break" screen. The program may re-calculate at that point.

If not, you could delete the 1098-T and reenter, but going back through the (ENTIRE) education interview usually resets it.

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MakersAuthor

It doesn't seem to matter what order the 1098-T and 1099-Q data are entered. The amount distributed and reported on the 1099-Q is larger than the tuition and fees paid and reported on the 1098-T. Since TT doesn't allow me to indicate that the excess distribution was offset by a scholarship, it regards it as subject to the 10% penalty.

Any other ideas for me?

Hal_Al

Employee

TT needs to know how much was paid by scholarship, in order to match it to the distribution amount and apply the penalty exception.

Be sure the scholarship amounts were entered, under educational expenses. This is usually done in box 5 of the 1098-T screen.

Colindaisy

How do I remove 10% penalty from Turbo Tax for 529 distribution since my son was on full scholarship and didn't use this?

JillS56

You cannot remove the penalty. If funds were withdrawn from a 529 Plan and not used for educational expenses because the student is on a full scholarship and did not use the funds for educational purposes.

Does the full scholarship include his room and board? If not, is the amount of room and board more or less than the amount withdrawn from the 529. If the amount went towards room and board then do not report the 1099-Q on his taxes. If a portion of the amount went for room and board, then the difference needs to be reported as income on his return. You do not have to enter the 1099-Q in order to do that. Just enter the excess 529 funds as other income on Line 8f of Schedule 1.

If the room and board is in excess of the 529 withdrawal, then do not report the 1099-Q on the tax return and you do not have to enter anything on Schedule 1.

The 1099-Q is a form that does not have to be reported on your taxes as long as the withdrawal is used for qualified educational expenses. If the funds were not used for qualified educational expenses you must report the 1099-Q as income and there is a 10% penalty for withdrawal of the funds for non-educational purposes.

MakersAuthor

Respectfully, JillS56 is wrong here. Distributions up to the amount of a tax free scholarship are NOT subject to the 10% penalty regardless of how that money is used. (Note though that the earnings on the original deposit(s) are taxable as ordinary income.) See IRS Publication 970 where it states:

Additional Tax on Taxable Distributions

Generally, if you receive a taxable distribution, you must also pay a 10% additional tax on the amount included in income.

Exceptions. The 10% additional tax doesn't apply to the following distributions.

...

3. Included in income because the designated beneficiary received: a. A tax-free scholarship or fellowship grant (see Tax-Free Scholarships and Fellowship Grants in chapter 1); b. Veterans' educational assistance (see Veterans' Benefits in chapter 1); c. Employer-provided educational assistance (see chapter 10); or d. Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance. This exception only applies to the extent the distribution isn't more than the scholarship, allowance, or payment.

...