529 withdrawal when scholarship is applied to the term bill

[tacopa]

Hoping someone can guide me on 529 withdrawal. Here is the situation. My daughter's Spring term bill has these line items:

Tuition & fees = $16,000

Scholarship    = $  6,000

Amount Due  = $10,000

I have 2 options. 

Option 1:  withdraw $10,000

Option 2: withdraw $16,000

I know that Option 1 has no tax implications.

My question is about Option 2. Do I need to pay tax on $6000 scholarship in Option 2, even though that money ($6000) is actually applied against the tuition & fees automatically by the university. My PA 529 GSP agent tells me that it is taxable. Is this right? 

I thought that if the Scholarship is used for Qualified Education Expenses,  it is not subject to taxes. Can someone clarify this?

Thanks.

[AmyC]

No, qualified expenses are not taxable income. I would absorb the extra $6,000 into room and board. You can take out more than $6,000. Room and board is higher than that, usually. Add books and supplies, etc it adds up.

• See page 52 for qualified distributions at IRS Publication 970, Tax Benefits for Education.
• Please see my 529 example with IRS information here.
• See also Publication 970, Tax Benefits for Education.

[Hal_Al]

Unless the scholarship is restricted; that is, it must be used for tuition, you have the option of how you allocate expenses.  For most people, it is better for the student to pay tax on some of the scholarship, rather than making some of the 529 distribution taxable of forgoing the tuition credit.  Up to $12,400 of scholarship can go untaxed depending on the student's other income. 

As AmyC says, you need to factor in other items: room and board (even if student lives at home), books and computers.

Expanding your example:

Tuition & fees = $16,000

Scholarship    = $  6,000

Room and Board = $5000

Books and computer = $1000

Student had $6,200 wages from summer job

Declare $6000 scholarship taxable. Student has $12,200 taxable income (6000 + 6200).  His standard deduction is $12,400*.  He owes no tax.

Use $4000 of tuition to claim American Opportunity credit.

That leaves $18,000 ($16,000 + 5000 + 1000 - 4000} of expenses for the 529 distribution.   You can withdraw  $18,000 tax free.

You  PA 529 GSP agent is essentially correct, scholarship CAN be taxable.

*Note: a dependent's standard deduction is $1100 or his earned income +$350, but not more than $12,400.  For purposes of this calculation scholarship is treated as earned income.

[tacopa]

Thanks Amy. Unfortunately, because of Covid,  the entire spring term was remote from home, so there is no rooming and boarding expenses for Spring term. And, PA GSP wants you to claim term by term, not by year!

Reading yours, and Hal-Al, it looks like it will be considered as income, if I decide to take it out.

Also, the University does not restrict to tuition only, it just applies to the entire bill and asks to pay the remaining amount after scholarship/grants.

[Hal_Al]

Even if the student lives at home, you may claim board (but not room). You may keep track of you food cost or use the school's meal plan charge for on-campus students, whichever is less.

[tacopa]

Thanks.

[tacopa]

Related question. What will be the State (I live in Pennsylvania) tax impact on scholarship withdrawal? My daughter will be getting the reimbursement, while I am the account holder. As an account holder and contributor to 529, I deducted the contributions from State Tax (PA)  years ago!!

I am not sure if PA taxes the entire amount or just the earnings. Anyone knows?

[AmyC]

PA  does not tax the distribution or interest if used on qualified education expenses.

[tacopa]

As I am doing taxes for my daughter, trying to figure out how/where to declare the scholarship as income. The example is : 16000 for Tuition & fees, and $6000 is the scholarship. When I got the 529 distribution, it was made to my daughter, and I did not take out $6000 in the distribution.  I guess, that excludes me from declaring it, right?

Also, since I paid more than half of my delighter support, I checked yes for "can she be claimed as someone's dependent".  If I do that, there is no AOTC. 

Can some one guide me?  She also earned about $7000.

[Hal_Al]

If you claim the student as a dependent, you will be the one claiming the AOTC.  Can you claim her? Yes,  probably.  She cannot claim the AOTC whether she is a dependent or not, if she is under 24.  Even if she could, it's only worth $1000 to her and $2500 to you (probably). 

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

So, it doesn't matter how much he earned. What matters is how much he spent on support. Money he put into savings does not count as support he spent on him self.

The support value of the home, provided by the parent, is the fair market rental value of the home plus utilities & other expenses divided by the number of occupants.

The IRS has a worksheet that can be used to help with the support calculation. See: http://apps.irs.gov/app/vita/content/globalmedia/teacher/worksheet_for_determining_support_4012.pdf

[tacopa]

Thanks for the quick reply. Let me clarify. In my example of Tuition 16K, scholarship $6k, the 1099Q box 1 has $10K, as my daughter got the distribution of just $10K which is what we actually paid to the college, as the scholarship was applied to Tuition. This 1099Q was in her name.

So, not sure how to claim AOTC with her filing as single, but checking the box that someone can claim as dependents, as her income is not just enough to cover all of her expenses - like  housing, food, tuition, fees, insurance, etc. I also checked the box that parents are not claiming her as dependent.

[Hal_Al]

There are three things you can do with your Qualified educational expenses (QEE):

1. Allocate some  to scholarships (so that the scholarship remains tax free)
2. Use some  to claim an education credit
3. Allocate them to the 529 distribution (1099-Q) so that it will not all be taxable

TurboTax allocates QEE, in that order, until you tell it otherwise.  depending on how much room, board, book and computer expenses you have, she may have to pay some tax on the 529 distribution.  But there's some manipulation you can do to lessen the effect. The interview is  complicated because it has to handle multiple scenarios, and mistakes can be made. 

Provide the following info for more specific help:

• Are you the student or parent.
• Is the  student  the parent's dependent.
• 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 1099-Q
• Box 2 of the 1098-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 charge. If the student lives at home, only the school's board charge for on campus students. 
• 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 you trying to claim the tuition credit (are you eligible)?
• Is the student an undergrad or grad student?

[tacopa]

• Are you the student or parent. = Parent
• Is the  student  the parent's dependent. = Yes. I (Parent) am eligible to claim.
• Box 1 of the 1098-T = 36,000
• box 5 of the 1098-T = 19,000
• 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 = Not that we know of.
• Box 1 of the 1099-Q = 27,000
• Box 2 of the 1098-Q = 10,000
• Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)?:  Student
• Room & board paid. If student lives off campus, what is school's R&B charge. If the student lives at home, only the school's board charge for on campus students. $7,000 On campus. $3,000 off campus
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers: $500
• How much taxable income does the student have, from what sources: $7000 (half from student worker - tax exempt, half from outside)
• Are you trying to claim the tuition credit (are you eligible)? I (Parent) am not eligible, because of income limit. 
• Is the student an undergrad or grad student? UNDERGRAD

[Hal_Al]

What does "$7,000 On campus. $3,000 off campus" mean?

$10,000 total?  The question is how much room & board expense can we allocate to the 529 distribution? 

What does  "$7000 (half from student worker - tax exempt, half from outside)" mean?  We need to know how much taxable income the student has and whether it is earned or unearned income.  "Student workers"  are exempt from FICA tax, but usually not income tax,  unless the wages  are classified as scholarship.  Then we need to know if it was already included in box 5 of the 1098-T or reported separately (W-2, 1099?).

[tacopa]

$10,000 is what is included in the 529 distribution. $7000 is for on-campus univ R&B in Fall, and $3000 for meals expense in Spring/Summer when the housing was closed for Covid, she studied from home and also from her  friends house off campus at the college.

$7000 income is not included in the scholarship in Box 5. It is in a separate w-2. They can be considered as earned income. 

And, thanks for helping.