1098-T Prior Year Adjustments and Impact to 529 Withdrawal

[BillyTheDutch]

My daughter's university (Univ of Arizona) made an error in distributing her Fall 2023 scholarships which triggered reporting of $2500 in Box 4 and Box 6 of her 1098-T and artificially increased Box 5 by $2500.   They incorrectly entered a $2500 scholarship as 2022 scholarship into my daughter's account, then immediately reversed that transaction.  After that they correctly distributed her Fall 2023 scholarships.  The university has claimed that everything is corrected by the Box 4 and Box 6 adjustments but Box 5 (2023 scholarships) is still $2500 higher than the actual scholarship that she received. 

This has created a problem because we withdrew from our 529 exactly the amount of her expenses minus her (actual) scholarships.  But, due to her scholarships being artificially high in Box 5, we show excess distributions from the 529.  

      (total qualified expenses) - (1098-T Box 5, scholarships and grants) = (allowable 529 withdrawal)

The university has washed their hands of the problem with the phrase "we can provide tax advice" and is clearly not going to correct the 1098-T because in their books balance.  But I still have to deal with the problem.   Is there a way in TurboTax to make an adjustment to the 1098-T numbers in some way that won't trigger an audit when my numbers don't match the 1098-T reported to the IRS?

In the Education Summary, after entering the 1098-T information, if I click "Edit" for "Scholarships/Grants", there is an interview question that states "Did <Student'sName> Aid Include Amounts Not Awarded for 2023 Expenses?"  If I answer "Yes" to this and enter the $2500, then everything works out.  Is this the correct way to handle this?  And, where in the forms/worksheets is this being entered?  I tried to verify how this is being applied in the forms but I'm not finding it.

Lastly, I need to understand if my 2022 taxes are impacted.  I understand that a positive amount (decrease) in Box 6 can trigger the need to refile the prior year taxes, however, I think Box 4 offsets Box 6.  I.e., Box 4 reduces our 2022 qualified expenses and Box 6 reduces 2022 scholarships so based on the above equation, my allowable 529 expenses in 2022 would be unaffected by these prior year adjustments.  Is this correct?  I shouldn't need to worry about refiling 2022 taxes.

Thank you for any help.

[Hal_Al · Accepted solution]

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. 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. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. You also cannot count expenses that were paid by tax free scholarships. You cannot double dip! 

References:

1. 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." 
2. IRS Pub 970 states: “Generally, distributions are tax free if they aren't more than the beneficiary's AQEE for the year. Don't report tax-free distributions (including qualifying rollovers) on your tax return”.

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. 

If you claim the tuition credit, you do need to report that you got one or that you qualify for an exception (the TurboTax interview will handle this)

You claim tax benefits, based on your own financial records, not the 1098-T. In the 1098-T screen, click on the link "What if this is not what I paid the school" underneath box 1. You will then be able to enter the actual amounts paid. You will also reach a screen that allows you to adjust the scholarship amount for "amounts not awarded for 2023 expenses".

Or if you find it easier, 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

[BillyTheDutch]

@Hal_Al: Thank you for your prompt reply, it was very helpful (and educational).