American Opportunity Credit denied

[hsvegmama]

We received an American Opportunity Credit for our daughter in college, but not our son.  I think the reason may be that he went on a payment plan because he is trying to pay for school w/o a loan.  His 2019 tuition was 15039 (that's not the full year because he hasn't paid all of spring semester), but he received a 5624 scholarship AND withdrew 10k from his MI 529 plan.  I see that makes it look like he essentially had NO education expenses.  HOWEVER, of the 10k from the MI 529 plan, only 198 was tax free earnings.  9216.84 was money we put in AFTER TAX.  So help me understand why we didn't qualify for a credit on his tuition?  We actually qualified for no credit at all for him...not even something smaller than the $2500.  And no....our AGI is not over the limit for married filing jointly.  Not even close.

[DianeC958]

When you put money into a 529 plan you may receive a credit or a deduction on your state return.  The idea for the 529 plan is that the money grows tax free and then when it is used for college you are not taxed on the money withdrawn.

When you use a 529 plan for college tuition you are not allowed to claim an education credit since the growth on the 529 plan is tax free.

Link to What is IRS form 1099-Q?

[hsvegmama]

I'm still not convinced that the AOC should have been denied. 

I have been poring over IRS Publication 970, especially pages 59 and 60.  I think, according to the IRS’s own examples, we should still qualify.  The example is eerily similar to our own....where the total tuition paid seems less than scholarship money plus the parent QEP distribution. In their example, the parents still receive an AOC.

I was wondering if, in fact, we qualify for the AOC, but owe a small penalty because we withdrew more than was actually needed.  Keep in mind, only the earnings (about $200) on the QEP were tax free.  The initial contribution ($9800) was AFTER Tax money.  And the state benefit for contributing to a QEP in no way comes close to that AOC.  IF this is supposed to be a way to entice people to save in QEP's, it is woefully misguided.

[NCperson · Accepted solution]

Assuming your income is under $160,000 (joint filing) and you answered all the questions correctly and your son is your dependent, here is what should occur

I'll assume that on the 1098-T, Box 1 is 15039 and box 5 is 5634.  That nets to 9405.

you should get the AOTC of $2500 but because of IRS math (see the form), that consumes 4000 of the 9405 leaving 5405 remaining.

whose social security number is on that 1099Q?  that is whose tax return the form goes on.  

since 10,000 was withdrawn from the 1099Q, there needs to be $10,000 of qualified higher education expenses. You already have 5405. if there is another $4595 in room and board and non-required books (there are other categories, but those are the normal ones)?  if yes, then none of the Box 2 earnings on the 1099Q is taxable.  If no, then there is a proration and a percent will be taxable,   

lastly, go back and check how you answered the questions for your daughter and son.  Maybe you inadvertantly answered a question differently for your son that caused the denial?

[hsvegmama]

I think I figured out a solution.  I am not sure why Turbo Tax wasn't doing this automatically.  I needed to switch to FORMS view rather than step-by-step and enter the amount $4,000 on line 17 of Part VI of the Student Information worksheet saying that my husband and I are claiming that amount as a credit on our taxes.  I'm pretty sure then that my son will have to pay a tax on any amount that he received from his MI-529 that exceeded his 2019 qualified educational expenses (and I actually think the tax relates to the EARNINGS portion of the withdrawal...not the initial contribution of after tax dollars we put into the account).  But the tax will be rather small and we are happy to pay it as long as we can still get the AOC.  Note for other users who may encounter this problem: I did learn about the override feature on the forms, but I was able to enter the $4,00 credit into line 17, column 1 without having to do an override.

[hsvegmama]

The 1099-Q has my son's social security number on it.  But I entered the information on my husband's and my taxes because of the way the Turbo Tax Prompt's are set in the education credits area.  

[NCperson]

@hsvegmama - nope , that 1099Q the needs to go on the return related to the social security number on it.  

if the higher qualified expenses exceeds Box 1 of the 1099Q, you don't even need to file it.  this could be the case as the payment went directly to the school and presumably paying off a statement that was all higher educational qualified expenses (do need to be careful of double dipping though).   

this is to your advantage as if there aren't enough qualified expenses, your son gets taxed on a portion of Box 2 earnings as HIS tax rate and not yours.  and quite possibly his income is low enough there is no tax to be paid.  he doesn't even need to file a tax return if a) he had no tax withholdings AND b) his total income is less than earned income +$350* OR $12,200, whichever is lower.   Anything that is taxable from Box 2 is considered 'earned income' while interest, dividends and capital gains is considered 'unearned' income. 

and you are correct any income is a portion of the BOX 2 earnings as what is in Box 3 was originally sent to the 529 plan as after tax dollars. 

 * this confuses some, let's say my child earns $8000 at a summer job and has $1,000 from the 1099Q and he has dividends from stocks in his name that are $400.   Then $9600 (total income) is not lower than 9350 (earned income + $350) so he is required to file.