I have read through questions/answers on this forum but want to be sure my "takeaway" is correct for the following scenario:
1098-T has $42,000 in Box 1 payments for tuition and required fees. Added $210 for required books for total expenses meeting AOTC definition of qualifying education expenses of $42,210 ($42,000 + $210). Son received $30,000 scholarship, $2600 Pell Grant, $250 refund for total of $32,850 in tax free educational assistance. From the $42,210 in educational expenses, will subtract the $32,850 leaving $9150 in qualified expenses for AOTC and 529 payments. Son also had $4424 in additional expenses for room/board/internet/utilities that do not qualify for AOTC, but meet definition of qualified expenses for 529 distributions.
Son got 1099-Q with Box 1 distribution amount of $12,000 from 529 plan. Parents got 1099-Q for $2000 Box 1 Distributions from 529 plan.
Parents plan to: Reduce the $9150 in AOTC qualifying expenses by $4000 so parents can claim AOTC. Will further reduce the AOTC qualifying expenses by $2000 to cover 100% of parents 1099-Q distribution. This will leave $3150 ($9150 - $6000) in qualifying educational expenses. Will add the $4424 of additional expenses that qualify for 529 distributions for a total of $7574 in qualifying 529 expenses that have not already been used to offset tax free educational assistance and AOTC credit. Will subtract $7574 from son’s $12,000 1099-Q distribution, leaving $4426 to declare as income on son’s tax return. I’m not sure if the whole $4426 is declared as income since my son did not actually contribute to the 529 plan, so the entire $4426 is new income to him, or, if we still run the calculation to determine the taxable portion of the $4426 distribution and only report the taxable portion. Is this treatment appropriate and do we report the entire $4426 as son’s income, or just the taxable portion?
From your scenario, the student will be taxed on the EARNIINGS on 4426 of the distribution.
There will be no penalty tax since the distribution was not completely used because of a scholarship.
You can enter the student as your dependent on your return, then the 1099-Q's (both) and then the 1098-T so that the TurboTax program can do the math. YOUR TurboTax program will tell you how much the student needs to claim. When you click "Maximize My Tax Break" for your return, your TurboTax program should take the 4,000 expense and give you the American Opportunity Tax Credit.
If you want to make the adjusted entries yourself, you would need to figure the taxable portion of the 12,000 distribution.
The formula is earnings (Box 2) times (expenses left) divided by distribution
You don't give the box 2 amounts from the 1099-Q
Box 2 times 7,574 divided by 12,000.
That will be the dollar amount the student will need to claim as other income. It should land on the student's Schedule 1 line 8.
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The $4426 is not the taxable amount. The taxable amount is 4426 / 12000 = 36.9% of the amount in box 2 of the 1099-Q (the earnings portion of the distribution).
If he has no (or little) other income, it's actually better if he declares $4426 of his scholarship to be taxable, rather than a portion of the 1099-Q. This is because scholarship income is treated as earned income for purposes of calculating a dependent's standard deduction. This usually results in no actual tax for the student.
Thank you--I really appreciate your time and expertise! Can a portion of the scholarship be declared as income for my son even if that scholarship by its terms is limited to paying only for tuition/fees (he can't use it to pay room/board etc.). If it has to be used for tuition/fees, can it still be treated as potential earned income for a student?
No. If the scholarship is restricted (must be used for tuition and fees), then the option to declare some of it taxable is not available. He will have to pay tax on some of the 529 distribution.