529/Amer Opp Credit: Tuition: $6000 paid by grandparents 529 Room & Board: $6000 paid by parents 529 Child not a dependent. Can gparents restore 529 and child take AOC?

[LDSmith]

TT is saying take the AOC and child pays tax on the excess 529 distribution earnings. Is this best/only way to handle this?

[KrisD15]

No, it is not the only way. 

Usually it is best as the tax on the distribution for the student is usually less than the credit for the Taxpayer claiming the student. 

The income on a 1099-Q, if taxable, needs to be claimed by the person that was issued the 1099-Q, either owner or beneficiary. Form 1099-Q should have been issued to the person that made the distribution. 

Room and Board expense can offset a distribution, but cannot be used for a credit. 

In order for the student to not be a dependent, that student needs to have supplied more than half their own support and scholarships do not count as the student suppling support. 

Type    letme    into the search and the program will show you a screen for the credit it is suggesting. You can change the allocation of expenses to the credit via this screen. 

[Hal_Al]

Q.Is this best/only way to handle this?

A. Yes, it's usually the best way. The AOC is worth (usually) much more than the tax on the partial distribution earnings. 

Most college age students can not claim the refundable portion of the AOC, even when they are not a dependent. 

So it depends on why this student is not being claimed as a dependent and if he has a tax liability. 

The 529 TurboTax (TT) interview is complicated.  It's bet to just not enter the 1099-Q if you know it is not taxable.  If there was only a $6000 529 distribution and there was, at least, $6000 room & board (R&B) expenses, then the parent's 1099-Q does not need to be entered.

The 1099-Q is  only an informational document. The numbers on it are not required to be entered onto your (or your student's) tax return. The interview is complicated and it's easy to make mistakes. Avoid it if you can and the parents can. 

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 don’t need it). 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.

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”.
3. "IRS Publication 970, Tax Benefits for Education states: If the entire 1099-Q went to qualified expenses, room and board, tuition, etc; then, you do not need to enter the form." 

Q. Can gparents restore 529?

A. No. You only have 60 days, after the distribution, the return the money to the 529 plan. 

Q. Can the AOC still be claimed?

A. Yes, most likely by the parents and not the student.  But, the grandparents 529 distribution will be partially taxable.  It is reported on the "recipient's" tax return. 

___________________________________________________________________________________________

Qualified Tuition Plans  (QTP 529 Plans) Distributions

General Discussion

It’s complicated.

For 529 plans, there is an “owner” (usually the parent, but sometimes a grandparent), 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 $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. A student, with no other income, can have up to $14,600 of taxable scholarship (in 2024) and still pay no income tax. 

[Hal_Al]

Provide the following info for more specific help:

• Box 1 of the 1098-T
• box 5 of the 1098-T
• Any other scholarships not shown in box 5
• Does box 5 include any of the 529/ESA plan payments (it should not)
• Is any of the Scholarship restricted; i.e. it must be used for tuition
• Box 1 of the parent's 1099-Q
• Box 2 of the parent's 1099-Q
• Box 1 of the grandparent's 1099-Q
• Box 2 of the grandparent's 1099-Q
• Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)?
• Room & board paid. If student lives off campus, what is 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.
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers
• How much taxable income does the student have, from what sources
• Are the parents eligible for the AOC (income not over $90K, $180K MFJ)
• Why isn't the student being claimed as a dependent (age, income, support)
• Is the student an undergrad or grad student?
• Is the student a degree candidate attending school half time or more?

[LDSmith]

• Box 1 of the 1098-T: $6,716.50
• box 5 of the 1098-T: $0
• Any other scholarships not shown in box 5: None
• Does box 5 include any of the 529/ESA plan payments (it should not): No
• Is any of the Scholarship restricted; i.e. it must be used for tuition: No
• Box 1 of the parent's 1099-Q: $6,659.00 
• Box 2 of the parent's 1099-Q: $3,971.37
• Box 1 of the grandparent's 1099-Q: $5,981.50
• Box 2 of the grandparent's 1099-Q: $2,048.96
• Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)?: Parent on Parent 1099-Q, Student on Grandparent 1099-Q.
• Room & board paid. If student lives off campus, what is 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: $12,920/academic year. Parents used $6,630 from 529 to cover.
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers. $30
• How much taxable income does the student have, from what sources. $4,900 after standard deduction ($19,500 AGI). Primarily W-2 earnings, some independent contractor (delivery driver).
• Are the parents eligible for the AOC (income not over $90K, $180K MFJ): No
• Why isn't the student being claimed as a dependent (age, income, support): Student took time away from college and renrolled for 2024 fall semester. 
• Is the student an undergrad or grad student? Undergrad
• Is the student a degree candidate attending school half time or more? Yes

[Hal_Al]

Assuming the $12920 was paid in 2024, there is enough room and board ($12920) to cover both 1099-Qs.   Both the parents and  the student do not need to enter their 1099-Qs. Even though your 529 money actually went for tuition, at tax time you are allowed to "allocate" it to R&B.  
Otherwise, the student will need to report some of his 1099-Q box 2 amount as income. But, he will not pay any tax, as the credit will, wipe it all out. 

Two more questions need to be answered regarding the student's dependent status.  For the fall term, did the student enroll in August or September?  Did the student still live with the parents during his "time off".* Either way, the student can claim the tuition credit if  the parents should forego claiming him as a dependent (even if they can claim him).  What's still unanswered is whether he gets the refundable portion of the AOC ($1000). 

Worse case: the parents forego the $500 dependent credit and the student only gets a $490 AOC or Lifetime Learning Credit (LLC) (in this case take the LLC and save the AOC for a later year). 

*There are two types of dependents, "Qualifying Children"(QC) and Other ("Qualifying Relative" in IRS parlance even though they don't have to actually be related). There is no income limit for a QC but there is an age limit, student status, a relationship test and residence test.

A child of a taxpayer can still be a “Qualifying Child” (QC) dependent, regardless of his/her income, if:

1. He is under age 19, or under 24 if a full time student for at least 5 months of the year, or is totally & permanently disabled
2. He did not provide more than 1/2 his own support. Scholarships are excluded from the support calculation
3. He lived with the parent (including temporary absences such as away at school) for more than half the year

[LDSmith]

Off-campus housing is a monthly lease, so the $6,630 is the total rent payments made in 2024. That money comes out of parents bank account and 529 distribution went directly back to that bank account.

Fall term started on August 26th. I had read the dependent rules as "5 months", so didn't think he qualified since he was not a student at the beginning of August. He did live with parents from January until leaving for his college in mid-August and he did not provide more than 1/2 of support.

Thanks for the guidance thus far.

[Hal_Al]

He can be claimed as a dependent for 2024.  As stated earlier, the parents can forego that (and the $500 other dependent credit) to allow him to claim the tuition credit. He still marks his return that he CAN be claimed as a dependent. He is not eligible for the refundable portion of the AOC. 

You can add food to the rent in determining the amount of R&B paid in 2024.  The amount of R&B allowed, for the 1099-Q, is the lower of your actual costs or the school's allowance for cost of attendance (essentially what on campus students pay).

So, he does need to enter his 1099-Q.  Theoretically TurboTax (TT) can handle it. But mistakes are frequent. The bottom line for you is: what ever amount of  the $2049, in box 2, that ends up taxable (I rough estimate about $500+), will be wiped out by the increased tax credit ( TT should use the LLC instead of the AOC). If you get something different, reply back and we'll kook for a workaround. You should get a screen "Amount used to calculate education credit".  You have a special situation. I would start with $3000 in that box. You may have to adjust it. 

Enter the 1099-Q before your enter the 1098-T.  You may have to delete both and start over.  For room and board, enter only the amount over $6659 (the amount allocated to the parent's 1099-Q). Enter your book expense.

Other things to be aware of:

1. The taxable portion of the 1099-Q is unearned income and the "kiddie tax" form 8615 will be generated. 

2. Any self employment tax (line 23 of form 1040), from the independent contractor gig, will NOT be wiped out by the education credit. 

[LDSmith]

Regarding entering the food expense, the college cost of attendance amount is total of $12,920. Since total rent payments for both semesters will exceed that amount, I thought it simplest to do 529 amount that covered all rent payments made in 2024 ($6,630) and not worry about the food portion. The parents 529 would then pay out $6,290 for second semester (max $12,920-$6,630).

Should food expense still be added to the college expenses screen even though 529 can't cover it?

Working on the other recommendations.

[Hal_Al]

Q. Should food expense still be added to the college expenses screen even though 529 can't cover it?

A. Simple answer: No. 

[LDSmith]

I removed all education items. 

Taxable Income (no change from earlier in the thread): $4,978

Tax Due on income: $483

Self-Employment Tax: $98

Box 1 of the grandparent's 1099-Q: $5,981.50

Box 2 of the grandparent's 1099-Q: $2,048.96

Box 1 of the 1098-T: $6,716.50

Box 5 of the 1098-T: $0

TT came back with the AOC. For the "Used for Credit" field, it seems that putting in $483 (instead of the $3000 that you suggested) to reduce Tax Due on Income to $0 minimizes the Excess Distribution. This minimizes State Tax Income due.

Does this seem to make sense. You had expected the LLC instead of AOC. 

[Hal_Al]

Q. Does this seem to make sense? You had expected the LLC instead of AOC. 

A. Yes, if you enter a smaller number, TT will give you the AOC instead.  You can use that if you're willing to use one of your 4 allowable AOCs on so little.  Or you can force TT to change it 

Type letme (no space between let & me) in the search box. Then press enter. Then  click  on the link "jump to letme''. 

TT will give you the option to select another tuition  credit.

Or

Type letme (no space between let & me) in the search box. When the dropdown list appears, click on letme rather than "jump to letme'. On the next drop down, click on the "jump to letme” link.

Q.  it seems that putting in $483 (instead of the $3000 that you suggested) to reduce Tax Due on Income to $0 minimizes the Excess Distribution. 

A. That  doesn't matter (only in this special case) because the tax is going to be 0, no matter what you enter. 

[LDSmith]

"Q.  it seems that putting in $483 (instead of the $3000 that you suggested) to reduce Tax Due on Income to $0 minimizes the Excess Distribution. 

A. That  doesn't matter (only in this special case) because the tax is going to be 0, no matter what you enter. "

Minimizing the Excess Distribution to have less taxable income does lower state taxes.

Since the credit is non-refundable, doesn't it make since to just force the tax due to zero and minimize state income tax?

Also, student has only two years of undergrad remaining. He was on parents tax return during first two years with 529 being used instead of the AOC.

[Hal_Al]

Q. Since the credit is non-refundable, doesn't it make since to just force the tax due to zero and minimize state income tax?

A. Yes.  Although most states don't tax income that low. 

"He was on parents tax return during first two years with 529 being used instead of the AOC."

The parents should look at filing amended returns, to claim the AOC (and report a little 529 earnings as income).