529 Withdrawal used for Home Down Payment Question

[Holden ItDown]

Hi folks,

I had a rather complex question and was hoping someone could help me out.  Back in early January 2021, I made a withdrawal of $53,049 from a Vanguard 529 account that my parents had set up with me as the beneficiary.  The purpose of this $53K withdrawal was to bolster the down payment on my first house.  So when 2022, rolled around, I received a 1099Q from Vanguard stating that had indeed withdrawn $53K, of that amount, 37.5K was earnings and 15.5K was basis.  

I did some research and clearly this is a non-qualified 529 withdrawal, so I should expect to pay a 10% penalty, on top of the regular tax on the earnings portion.  But here's the catch, I went to a US military academy, where tuition is paid for and you also get a 4 year college degree.  Per Section 2005(d) of Title 10 of US Code, it appears that my 10% penalty gets waived  (https://www.law.cornell.edu/uscode/text/10/2005).  This penalty exemption is further reinforced by IR publication 970, page 48 of the pdf (https://www.irs.gov/pub/irs-pdf/p970.pdf)

The issue right now appears to be with Turbo Tax's software.  When I enter my 1099Q numbers in the appropriate section, Turbo Tax tries to auto-calculate how much I owe to the IRS and my home state.  These numbers get displayed near the top of the screen.  Right now Turbo Tax says I owe just north of $12K in federal taxes and $3K in state taxes.  I'm 99% sure though that Turbo Tax is not giving me the 10% penalty exemption, or at the very least they are not explaining how the back-end of the turbo tax software arrives at those 12K and 3K numbers.

I should only be paying taxes on the 37.5K earnings.  I did some back of the napkin math and I fall in the 24% tax bracket (my regular income plus $53K for 2021).  24% x $37.5=$9000.  So I don't know why Turbo Tax is saying I owe 12K in federal taxes.  If I could manually change this number from 12K to 9K I wouldn't have this problem, but I can't figure out a way to force the numbers.

Any help would be appreciated!  And if someone thinks they have an idea of how to remedy but needs more info, then I can send screenshots or pictures on request.

Very Respectfully,

Holden

[Hal_Al]

Q. 24% x $37.5=$9000.  So I don't know why Turbo Tax is saying I owe 12K in federal taxes. 

A. 9000 + (0.10 x $37,500) = About $12K. so that's the most likely explanation. 

You may (probably) not qualify for the exception, because of timing. The consensus is that you (or your parents) should have withdrawn the 529 money in each  the years you attended the academy, in order to qualify for the exception.  That's my reading of Pub 970, but it's not explicit. The TT interview also seems to take that attitude. But there is disagreement on the every year part, but, even then,  most still say the distribution  must be done before graduation. 

In order to get TurboTax (TT) to apply the military academy exception, to the penalty, you have to indicate you attended school/academy, in 2021,  in the 1099-Q interview.  If you have desktop software (not online), you can use the forms mode. 

[Holden ItDown]

That makes sense, yeah I did the the Academy education from 2012 to 2016 and my withdrawal wasn't until 2021, so the timing is way off.

Thank you!!