529 and Coverdell distribution too close to education expenses to claim full American Opportunity Tax Credit (AOTC)

[masonparent]

Hello Experts, 

Hope to get some help here, your help is greatly appreciated!

I have two 1099-Q, one for Coverdell from Schwab $3,000 with recipient as my daughter SSN, another one from state 529 total $13,830 to my SSN. 

But the expenses from last year 1098-T shows $15,053 on box1, and $1,750 on ox 5 and $885 for box 4, My daughter started living in off campus apartment starting Aug last year for about $3,500 for apt rental total for 2023, also grocery and a school trip airfair toral $600, and $180 books. I need $4,000 expenses not covered by 529/coverdell to claim the full AOTC. But so far I don't have $4,000 extra expenses.

Since the Coverdell one has her SSN, and she earned summer intern income of $8,580, I will file tax for her and enter 1099-Q Coverdell $3,000 on her return, this way my return has less 1099-Q distribution and I can have more expenses than 1099-Q to claim AOTC, although still not enough to claim full AOTC.  TT thinks my cost basis for coverdell is less than the value at the end of last year so it think she need to pay tax around $230.

I have calimed AOTC for 2 years and this will the third year. For the graduation year, I plan to use the Lifetime Learning Credit. 

For the expenses for 2023, I can not use the living rental fee for the first half of the year since she lived in school housing and I paid it at the end of 2022, so I guess it is not 2023 expenses.

I took the coverdell money out in Dec 2023, I am still within 60 days to roll over it since the TT form asked if I rolled it over. But it will be in 2024, not sure if the trouble worth it.

Also I dont think the cost basis calculated for the end of 2023 by Schwab was correct, it used the cost basis of my most most recent purchase, but overall I lost money on this account, Schwab does not have the full history since it was transferred from another brokerage. Can I use my total contribution as the cost basis? For example if I contributed 2,000 dollar a year for 5 years, now I only have $9,000 in it, I lost money.

Is there any way to take the full AOTC? I dont think I can take Life time learning credit this year and take AOTC later, since I will have the same issue for this year.

For the graduation year of 2025, I plan to pay the school in Jan 2025 instead of Dec 2024 so I have expenses for the 5th year to use Life time learning credit (LLC) since I can only take AOTC 4 years. Or may be I should take LLC for 2024 tax year since 2024 has more expenses and AOTC for 2025 since it only needs $4,000.

Sorry for the long question.

[masonparent]

@Hal_Al hope to get your help on this question, any help is greatly appreciated!

[Hal_Al]

Q.Is there any way to take the full AOTC?

A.  Yes. Simply allocate $4000 of tuition to the AOTC.  You do not have to allocate expenses to the ESA/529 first. That reduces that amount of expenses being allocated to the ESA/529, and some of it may be taxable. 

What is in box 2 of your 1099-Qs?  If you lost money, there should be no earnings in box 2 and there may be little or no potential for any part of the distributions to be taxable. Only the box 2 amount is potentially taxable, not the box 1 amount.  But, expenses are allocated to the box 1 amounts, when doing the calculations. 

Q. Can I use my total contributions as the cost basis?  

A. Yes, if you've got the records to support it.  You may have to adjust for past year distributions. 

Airfare is not a qualified educational expense.  For off campus living you may use the lesser of your actual rent and food cost or the school's "allowance for attendance" (basically what on campus students pay for R&B). 

Q. For the expenses for 2023, I can not use the living rental fee for the first half of the year since she lived in school housing and I paid it at the end of 2022, so I guess it is not 2023 expenses?

A. That is correct.

Q.  Maybe I should take LLC for 2024 tax year since 2024 has more expenses and AOTC for 2025 since it only needs $4,000.

A. That's a good plan to  crunch the numbers to see which way is best.  Books and course materials, including computers, are not qualified expenses for the LLC, but are for the AOTC.  R&B are not qualified expenses for either credit, but are for ESA/529 distributions. 

[masonparent]

@Hal_Al Thanks so much for your help!

What is in box 2 of your 1099-Qs?

For the Coverdell one that is used for my daughter box 1 is 3,000 and box 2 and 3 are all blank, I guess it is becuase it does not have records since it was transferred from other brokerage. There is a fair market value of about 7000 at the end of last year.

this box is blank/not checked: recipient is not beneficery.

For the 529 one that is used for my return, box 1 is 13830, box 2 is 1932 and box 3 is 11898.

this box is checked: recipient is not beneficery.

Not sure how to allocate $4000 of tuition to the AOTC first, I will check TT to see where I can do that. 

For 2024 and 2025 (graduation year) planning, I see LLC is 20% of tuition up tp 10,000 and that is only possible for 2024 since it is a full year and tuition is more than 10k. In 2025 it is less than 10k so use AOTC might be better.

Thanks so much for your help!

[Hal_Al]

To keep it simple, I would not enter the ESA 1099-Q, on the student's return. It appears that the earnings are less than 0 and you do not need to allocate any expenses to that distribution.  You also do not need to enter the 1098-T or any expenses on her return, unless she needs to report some of the scholarship as taxable. 

Furthermore, again, to make it simple, I would not enter the 529 1099-Q, on your return.  It's fairly clear that you have enough expenses to cover the $13,830 distribution, even after allocating $4000 to the AOTC. If you come up short, then make some of her scholarship taxable, on her return.   Again you do not have to allocate a full $1750 of expenses to the scholarship. In that case, she enters the 1098-T on her return too (it can go on both yours and hers, allocating  as needed).  For simplicity, on her return, enter the 1098-T with $0 in box 1 and the amount of scholarship you calculate as taxable in box 5. Taxable scholarship is treated as earned income for a dependent's  standard deduction (earned income + $400), so she will not pay any tax. 

  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 (you've done that) to see if there were enough expenses left over for you to claim the tuition credit. 

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." 

1. 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”.

To claim the AOTC, you simply enter her 1098-T on your return.  To keep it simple, enter the 1098-T with $4000 in box 1 and box 5 blank.  What you enter, in TT, is not sent to the IRS. It's just used to do the calculations. 

Theoretically, TurboTax can handle the entering of all the info you have and come to the right answers. But, it can get messy. 

[masonparent]

Thanks so much @Hal_Al  I will give that a try.

[Hal_Al]

I edited my last reply to account for the scholarship, if needed.  The key to all this is that you are allowed to allocate your expenses to where it gets you the most tax benefits: the AOTC, the scholarship, the ESA distribution or the 529 distribution.  One caveat; if the scholarship is restricted (unusual), that is , it must be applied to tuition, then you will have to allocate $1750 of tuition to the scholarship. 

[masonparent]

Thanks @Hal_Al so much!

I will double check on the scholarship. I like the idea of switching the scholarship to her return.

Have a great day!