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TT won't use education expenses to offset 529 plan withdrawals

Forum|Forum|6 years ago
February 28, 2020
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I'm filling out my son's tax return. He's a senior in college, still a dependent on my return, but he's got some earned income from a summer job, and a relatively small amount of dividend and capital gains income from an E-Trade account. His income is such that he gets a refund of all withheld taxes from his summer job, and no taxes owed on his investment income. So far, so good.

But...he's got a 1099-Q showing $37,000 in distributions from his 529 account, as well as a 1098-T from his college showing $25,000 in scholarship money and $45,000 in tuition payments. So, $45K in tuition minus $25K in scholarships leaves $20K in tuition. That $20K plus $15K for room and board plus another $2K for books and supplies adds up to $37K which should completely offset the 529 distributions. However, when I enter all the expenses, TT tells me he's not eligible for an education deduction or credit because either a) I can claim him as a dependent on my return, OR b) distributions exceed the education expenses (which they don't), OR c) there were no net qualified education expenses (which there were). I've started and re-started his return multiple times, and worked carefully through each Easy Step section, and always wind up owing taxes on that $37K in 529 distributions. What gives?

Best answer by SusanY1

Since he is a dependent on your return, the education expenses and deductions from the 1098-T would normally be on your return (for the education credit), but it appears here that the expenses were covered by the 529 plan distribution so there is no credit, so there is no need to enter the form, and his scholarships are less than tuition so there is no taxable scholarship income for him to report here, so you can delete this form from TurboTax.

Since the Form 1009Q distribution was completely offset by qualified expenses, it is not required to be listed on either your tax return or his - the IRS only requires that it be entered on a taxpayer's return when there is a taxable distribution. There does not appear to be a taxable distribution in his case. Also, delete this form.

Keep both forms and your receipts along with the tax returns (yours and his) in an easy to locate file for three years on the off-chance that either of you are later asked to support the expenses (this is uncommon, but it does occasionally happen.) Should the IRS send a letter addressed to either of you asking for support for the expenses to match the 529 distribution, you will be able to make quick copies and forward them along.

SusanY1Answer

Since he is a dependent on your return, the education expenses and deductions from the 1098-T would normally be on your return (for the education credit), but it appears here that the expenses were covered by the 529 plan distribution so there is no credit, so there is no need to enter the form, and his scholarships are less than tuition so there is no taxable scholarship income for him to report here, so you can delete this form from TurboTax.

Since the Form 1009Q distribution was completely offset by qualified expenses, it is not required to be listed on either your tax return or his - the IRS only requires that it be entered on a taxpayer's return when there is a taxable distribution. There does not appear to be a taxable distribution in his case. Also, delete this form.

Keep both forms and your receipts along with the tax returns (yours and his) in an easy to locate file for three years on the off-chance that either of you are later asked to support the expenses (this is uncommon, but it does occasionally happen.) Should the IRS send a letter addressed to either of you asking for support for the expenses to match the 529 distribution, you will be able to make quick copies and forward them along.

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N

NCPERSON1

i agree with @SusanY1 explanation with one exception; there was no discussion of AOTC. are you eligible? (joint income under $160,000). If you are not eligible, then I agree with @SusanY1 comments. Otherwise, here is how it should work.

1) 1098-T goes on YOUR tax return (I assume your child is your dependent)

2) There are $20,000 of net expenses on the 1098-T. (Box 1 less Box 5)

3) you should get $2500 of AOTC credits which consumes $4000 of the expenses (IRS math) But look at form 8863 for the exact amount. $4000 is the maximum.

4) that leaves $16,000 of expenses and let's add in the $15,000 for room and board and $2000 of books or $33,000

5) Assuming your child's social security number is on the 1099Q, there was a $37000 distribution from the 529 but only $33,000 of expenses remaining ("the double dip rules"). Therefore $4,000 didn't need to be distributed so $4000/ $37000 or 10.8% of the BOX 2 earnings on the 1099Q is taxable EARNED income to YOUR CHILD (not you!). And if he has no federal withholdings and his Earned Income is lower than lesser of total Income + $350 OR $12,000, then there is no need to file as there are no taxes to be paid.

make sense? it's not easy!

F

FeldgrepAuthor

We are NOT eligible for the AOTC. Since the 529 disbursements are paid to our son, as the beneficiary, rather than myself, as the account holder, it seemed to make logical sense to include the disbursements, and therefore the offsetting expenses including the tuition payments from the 1098-T, on his return. TurboTax EasyStep seemed to be fine with this approach, up until the point where I entered the last of his offsetting expenses, at which point the program insisted that he couldn't claim a CREDIT (which I wasn't trying to claim) because he was a dependent on my return, and his 529 distributions were therefore taxable income for him.

SusanY1

Great catch on the AOTC -- yes, this should definitely go on your return if you are eligible for this credit.

If this applies to you, please print out this wonderful illustration that @NCPERSON1 has shared and add it to your file so that you'll remember this next year, too!

Trying to combine these various education benefits gets fairly complicated and this is a fantastic breakdown of how it works when you are eligible for the American Opportunity Credit.

Thank you, @NCPERSON1!!

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Carl11_2

Employee

I'm filling out my son's tax return. He's a senior in college, still a dependent on my return, but he's got some earned income from a summer job, and a relatively small amount of dividend and capital gains income from an E-Trade account.

Bottom line is, your son will file his own tax return to report that income.No exception here.

His income is such that he gets a refund of all withheld taxes from his summer job, and no taxes owed on his investment income. So far, so good.

Yep. Now comes the "but". 🙂

But...he's got a 1099-Q showing $37,000 in distributions from his 529 account, as well as a 1098-T from his college showing $25,000 in scholarship money and $45,000 in tuition payments.

Bottom line with no exception here. If the 1099-Q has the student's SSN in the recipient's box, then *IF* the 1099-Q is required to be reported, (I stress *IF*) the student has no choice and must report that 1099-Q on the student's tax return.

So, $45K in tuition minus $25K in scholarships leaves $20K in tuition.

I'm with you so far.

That $20K plus $15K for room and board plus another $2K for books and supplies adds up to $37K which should completely offset the 529 distributions.

So the reality is, there is a total of $62,000 of "third party income" received from other sources. $37K in 529 distributions added to $25K of scholarships gives a total of $62,000 of "third party support" provided to the student. Keep this number in mind.

The student has $37K in qualified education expenses (tuition, books and lab fees) and another $15K for the unqualified but allowed expense of room and board that was paid "in direct support" of the education. That gives a total of $52,000 in deductible expenses for education.

Since $62,000 in third party support was received in 2019 and only a total of $52,000 of that was used to pay for qualified education expenses and "allowed" expenses, that means there's $10,000 of taxable income remaining.

Therefore, while you will still claim the student as your dependent, it is the student who will report "ALL" of the education stuff on their tax return. It is the student that will pay taxes on the excess $10K of third party support. Additionally, the student will be taxed at the higher, parents' tax rate on that $10K only.

TT tells me he's not eligible for an education deduction or credit because either a) I can claim him as a dependent on my return,

..and that is a true statement.

b) distributions exceed the education expenses (which they don't),

Unless I missed something, using your numbers the third party support received by the student, exceeds the total of all the qualified education expenses and the allowed education expenses of room and board.

c) there were no net qualified education expenses (which there were).

I don't see any qualified out of pocket expenses at all here. Remember, out of pocket money can not be used for room and board. Neither can scholarships. Only 529 funds can be used tax free for room and board.

Here's the scenario of how the IRS prioritizes and applies this stuff.

--------------------------------------------------------------

First, scholarships & grants are applied to qualified education expenses. The only qualified expenses for scholarships and grants are tuition, books, and lab fees. that's it. If there is any excess, then it's taxable income to the student. It automatically gets transferred to and included in the total on line 7 of the student's 1040.

Next, 529/Coverdell funds reported on 1099-Q are applied to qualified education expenses. The qualified expenses for 1099-Q funds are tuition, books, lab fees, AND room & board. That's it. If there are any excess 1099-Q funds they are taxable. The amount is included in the total on line 7 of the student's tax return..

Finally, out of pocket money is applied to qualified education expenses. Out of pocket expenses can only be used for tuition, books, and lab fees. That's it. Out of pocket expenses can not be used for room and board.

When you have a 1099-Q it is extremely important that you work through the education section of the program in the order it is designed and intended to be used. If you do not, then there is a high probability that you will not be asked for room & board expenses, and you could therefore be TAXED on your 1099-Q funds.

Finally, if "all" qualified expenses are covered by scholarships, grants, 1099-Q funds and there is ANY of those funds left over, the left over excess is taxable. While the parent can still claim the student as a dependent, it is the student who will report all the education stuff on the student's tax return. That's because the STUDENT pays the taxes on any excess scholarships, grants and 1099-Q funds.

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NCPERSON1

@Carl11_2 - sorry but the math isn't making sense

if I think about this as 'sources and uses"

1) there were $62k of sources - the $37k from the 529 distribution and $25k from the scholarships

2) there were $62k of uses - $45k for tuition, $15k for room and board and $2k for books

the net is zero and there is no need to report the 1099Q.

same situation, but now AOTC is included:

1) there were $66k of sources - the $37k from the 529 distribution and $25k from the scholarships and $4000 for AOTC (which yields the $2500 credit)

2) there were $62k of uses - $45k for tuition, $15k for room and board and $2k for books

3) therefore $4000 of the 529 distribution was not required meaning that $4k/$37k or 10.8% of 1099Q / Box 2 is taxable. I'd certainly pay tax on the 10.8% to get the $2500 credit!!!!!

if I look closely at your math it appears the scholarship was used twice. first, it was netted against the $45,000 of tuition (to yield the $20,000) and then later it was declared a 'source' as part of the $62,000 when it was already netted out of the figures to compare to the $52,000- hence it was used twice. also, the student did not have $37,000 of qualified expenses - it was $62,000 (tuition = $37000, room and board = $15000 and books = $2000); that $37,000 off the 529 is a 'source' and not a 'use'. If I remove the extra $25,000 from the duplicate scholarship "source" and reflect the additional $15,000 of qualified expenses which is a use that brings the income of $10,000 you originally presented back to zero.

hope this brings some clarity to the subject.....

Carl11_2

Employee

1) there were $62k of sources - the $37k from the 529 distribution and $25k from the scholarships

The $25K gets applied first, and it can not be applied to room and board. It can only be applied to the 47K of qualified expenses. That leaves $22K left.

$22K of the 529 is applied to the remaining qualified expenses, meaning that nobody qualifies for any tax credits or deductions at all. Not a penny. But there's still $15K left over from that 529 distribution which is applied to the room and board. There's nothing left over that's taxable (don't know why I came up with $10K taxable before) but the point is, nobody qualifies for any education credits or deductions of any kind. Not a penny.

D

Daddio253

I am experiencing a similar situation. My son is a dependent on my taxes. He had eligible education expenses which I paid with funds from a 529 plan. I received a 1099-Q on which I am the recipient. The amount that we withdrew is fully offset by eligible, documented education expenses. TT will not give me the option to enter any education expenses because my income is too high to be eligible to deduct them. But I have already entered the info from the 1099-Q. TT is seeing that as taxable income with no corresponding offset. If I understand the response from SusanY1 correctly, she is suggesting I could omit the info from the 1099-Q from my return because it is entirely offset by eligible expenses. I am only required to include it if the income reported on the 1099-Q exceeds the eligible expenses. I can omit that form and simply keep the documentation of those expenses handy in case the IRS asks for clarification at some future date. Do I understand that correctly? Are distributions from 529 plans reported directly to the IRS or only if included in a return?

AmyC

Employee

The IRS receives all tax forms. The IRS is getting the 1098 and the 529. The IRS also is aware of room and board expenses. As long as your 529 is reasonable, the IRS will not care. In fact, when you enter the 529 in the program and then have expenses to offset, the form is not entered on your return. You can delete the Q and put it with your tax file.

Reference: Publication 970, Tax Benefits for Education.

@Daddio253

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