529 Plan - Scholarship withdrawal and 10%penalty

[vvk4]

My son received scholarship of 4k in spring and 4k in fall for 2023 and free tuition. He paid 5k towards tuition fees in summer. I withdrew the 5k from 529 plan for which I received 1099-Q. I wish I had paid from 529 plan directly to university so that 1099-Q would be in his name.  Last 2 years my son has been filing his own taxes with 1098-T so that standard deduction completely covers his scholarship receipts of 8k and he pays no taxes. The 1099-Q is in my name, I am being taxed on Earnings and being assessed 10% penalty. From what I have read about 529 plan, the penalty may be waived if there are extenuating circumstances, such as if the beneficiary receives a scholarship. How do I handle situation so that my son can continue filing taxes and not have to pay taxes on his 8k scholarship, while I avoid the 10% penalty for withdrawal from 529 plan.

[Hal_Al]

Room and board (R&B) are qualified expenses for a 529 distribution. R&B are not qualified expenses for a tuitions credit or for his scholarship to be tax free. 

So, you should claim his room and board (even if he lived at home) against your 1099-Q. Better yet, just don't enter the 1099-Q. 

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”.

[Hal_Al]

@vvk4 said " Last 2 years my son has been filing his own taxes with 1098-T so that standard deduction completely covers his scholarship receipts of 8k and he pays no taxes."

What about the American Opportunity Credit (AOC)? The parent should be claiming that, unless their income is too high (more than $90K, $180K married).  The student is not eligible for the refundable portion of the AOC. 

If taxable scholarship is his only income, the first $13,850 is tax free. Scholarships that pay for tuition, fees, books and computers is not taxable. 

[vvk4]

Thank you very much. Your knowledge about taxes is amazing.