529 withdrawal

[PVAR_JAX]

Hello there, I have a 529 for my son set up. in 2019, he worked in spring semester and earned enough to pay for the fall semester after taking into account for his living expenses while he was working. He is an out of state student.  Can I still withdraw funds tax free from 529 even though he paid for it? It seems I can't claim him as dependent. Can he still take American Opportunity credit if he files his returns? His earning are enough that he will need to file a tax return for 2019.

Thank you so much!

[Hal_Al]

Q.  Can I still withdraw funds tax free from 529 even though he paid for it? 

A. Yes, since he is the beneficiary of the plan.  It is not necessary that any of  the 529 plan money pay for the actual tuition and other expenses.  It is only necessary that he incurred qualified expenses (including room & board) in the same year as you made the withdrawal.

Q. Can he still take American Opportunity credit (AOC) if he files his returns?

A. Maybe. If he is over age 23, then yes.  A student, under age 24, is only eligible for the refundable portion of the American Opportunity Credit if he supports himself by working. He cannot be supporting himself on parental support, 529 plans or student loans & grants.  More than half his support must come from earned income in order to claim the  Refundable portion of the AOC.  If he does not  qualify as your dependent, he can claim the non refundable portion of the AOC.   You will have to coordinate your taxes. You may not claim the same expenses that he uses for the AOC, to claim the 529 plan earnings exclusion (see example below*).

Q.  It seems I can't claim him as dependent.  Is that right?

A. Maybe. 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 (but not loans)are considered third party support and not as support provided by the student. 529 plan money is considered as provided by the parent, if the parent is the owner.
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.

Furthermore, there is a rule that says IF somebody else CAN claim him as a dependent, he is not allowed to claim himself. If he has sufficient income (usually more than $12.000), he can & should still file taxes. In TurboTax, he indicates that somebody else can claim him as a dependent, at the personal information section.  TT will check that box on form 1040.

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*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 529 Plan earnings exclusion on the 1099-Q. 
Example:
  $10,000 in educational expenses(including room & board)

   -$3000 paid by tax free scholarship

   -$4000 used to claim the American Opportunity credit (on the student's return, in your case)

 =$3000 Can be used against the 1099-Q ( on the parent’s return)

Box 1 of the 1099-Q is $5000

Box 2 is $600

3000/5000=60% of the earnings are tax free

60%x600= $360

You have $240 of taxable income (600-360)

[Carl]

It seems I can't claim him as dependent

More than likely your assumption on that is incorrect. Please note the following on a student qualifying as a dependent.

 - THere is no requirement what-so-ever for the parents to provide the student any support. Not one single penny. The support requirement is on the student, and only the student. That requirement is:

 "If the student did not provide more than 50% of the student's own support, then the parents qualify to claim that student on the parent's tax return. If the student will be filing a tax return then the student "must" select the option for "I can be claimed on someone else's return"."

The key word here is *QUALIFY*. So even if the parents don't claim the student, it doesn't matter. If the student "qualifies" to be claimed on the parent's return then the student *MUST* select the option for "I can be claimed on someone else's return" when the student completes their own return if required.

 - The student's earnings do not matter. The student could earn a million dollars and still qualify as a dependent on the parent's tax return. 

 - There are only two possible ways a student can provide more than 50% of their support.

  1. The student has a W-2 job or is self-employed and earns sufficient amount to provide more than half their own support and actually *does* provide more than half of their own support.

  2 - The student is the *primary* borrower on a qualified student loan, and sufficient funds are distributed by the lender to the student in a tax year, in an amount that would enable them to actually provide more than half of their own support.

Now, even with the above two items, it's still perfectly possible for the student to *not* provide more than half of there support *no* *matter* *what* they do.  As an example, scholarships, grants, 529 distributions, gifts from Aunt Mary, etc., are all considered third party support. So if the student receives $50,000 in scholarships in a tax year, yet their qualified education expenses are only $20,000, that leaves $30,000 of "third party support" for the student. Since the qualified education expenses are also a part of the student's support, that would mean the student would have to spend $50,000 *of their own money* on support, in order to claim their provided more than half of their own support.

There's no way one can justify spending $100,000 or more in a tax year on support for an undergraduate college student. So this is one (of many) possible ways a student can earn a million dollars, yet still qualify to be claimed as a dependent on the parent's tax return.

[Hal_Al]

Note: Carl's answer applies to full time students under age 24.  If the student is 24 or older or was not a full time student, for parts of 5 months or more,  he cannot  qualify as a dependent under the qualifying child rules, but must qualify under the qualifying relative rules*.

* Support test:

• Qualifying Child -  The student must not have provided more than half his own support
• Qualifying Relative - The taxpayer must have provided more than half the student's support.