AOTC with 529, loans, grants, room and board, and scholarships

[magdalynaa]

I am struggling with allocating educational expenses to maximize AOTC while taking into account unrestricted scholarships, restricted scholarships, grants, loans, room and board, and 529 distributions, and I'd appreciate any help.  This seems so convoluted to me.

Background: Daughter is 19 and in her second year of college.  She has $5,047 of W2 income from her job. Her federal withholding was $0, but she had about $50 in state withholding.  We think claiming her as a dependent will be more financially beneficial for us (parents) than for her to claim herself.  Total parental income is $113,000 with $84,000 taxable income, so we are well under the limit to claim the full AOTC.  Daughter attended two universities in 2024 that I'll call University A and B.  University A is a nightmare for my calculations, but University B seems very simple.

Tuition and fees at University A was $3,515. She received a restricted scholarship (I verified) for $1,985 that can only be used for tuition and fees.  She paid $207 for books and supplies.  My calculation is that qualified education expenses at University A is: $3,515 tuition and fees - $1,985 restricted scholarship = $1,530 + $207 books = $1,737 adjusted qualified expenses at University A.  

She received an unrestricted scholarship of $833.  She received an unsubsidized loan of $1,019 and a subsidized loan of $797.  She also received a Pell Grant of $449.  She received another grant of $785 that was totally unexpected, and it was meant to cover three quarters of school, two of which happened in 2023 (she got it halfway through 2024).  I added these all up to get $3,883 in scholarships/grants at University A.  BUT...

She has a state-sponsored 529 plan and received total distributions of $1,134 for 2024.  Room and board at University A was $3,040.  Is it okay to allocate the entire $1,134 distribution to University A for room and board if we didn't actually pay that amount to University A all at one time?  We actually requested more than we needed for University A, reimbursed some of it (she overestimated book costs), she got the unexpected $785 grant, we sent the whole $785 to the 529 plan, and then we paid some from the 529 plan to University B later in the year.  Basically... $1,134 is mathematically accurate for the total 529 distribution for the year for both schools, and that is what it on her 1099-Q.  It just didn't all go to University A or go all in one chunk, so I'm not sure I'm allowed to say "she paid $1,134 to University A from her 529 plan for room and board."

Tuition and fees at University B was $5,095.  She received a restricted scholarship that can only be used for tuition and fees in the amount of $3,094 (I verified it was restricted).  She paid $61 for books and supplies.  She received an unrestricted scholarship of $1,000, and she received $75 from a subsidized loan.  She lived off-campus.  University B expenses seem pretty straightforward since there is no room and board, grants, etc.  I calculated qualified education expenses at University B to be: tuition and fees of $5,095 - $3,094 restricted scholarship = $2,001 + $61 books = $2,062 qualified expenses at University B.  Is that accurate?

So what I'm not quite sure of is...

1. Are my numbers correct for qualified expenses?  It would be $1,737 for University A + $2,062 for University B, which is a total of $3,799.  That is below the $4,000 maximum for AOTC, but that's all I can document in qualified expenses.  I thought I couldn't claim any room and board for AOTC.

2. Should she claim $3,799 as taxable income on her taxes so we can claim as much AOTC as possible if we claim her as a dependent?  I don't mind paying any taxes due on it for her, but it didn't look like she owed any (from my initial run at the numbers).

3. What do I do about that $785 grant, since we didn't know it was supposed to partially count towards expenses for 2023?  Should we only claim $261 for that grant ($785 divided by three quarters of school, with only one in 2024)?

4. How do I account for that grant since I paid the entire $785 to the 529 plan when she received it in 2024?  She didn't keep any of it since it went to the 529 plan, and the 529 plan sort of "accounted" for it by adjusting what was distributed to her for the entire year on her 1099-Q.  Can I deduct the $785 from my total for her scholarships/grants for University A in that calculation, if so?

Any help would be amazing.  I feel like I'm overthinking this, but I have zero interest in running afoul of the IRS.

[Hal_Al]

Qualified Tuition Plans  (QTP 529 Plans) Distributions

General Discussion

It’s complicated.

For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q. 
The 1099-Q gets reported on the recipient's return.** The recipient's name & SS# will be on the 1099-Q.
Even though the 1099-Q is going on the student's return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because he is your dependent.

You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The American Opportunity Credit (AOC or AOTC) is 100% of the first $2000 of tuition and 25% of the next $2000 ($2500 maximum credit). The educational expenses he claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit,  that gets him an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. Another special rule allows you to claim the tuition credit regardless of whose money was used to pay the tuition.
In addition, there is another rule that says the 10% penalty is waived if he was unable to cover the 529 plan withdrawal with educational expenses either because he got scholarships or the expenses were used (by him or the parents) to claim the credits. He'll have to pay tax on the earnings, at his lower tax rate (subject to the “kiddie tax”), but not the penalty.

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 earnings exclusion on the 1099-Q. 
Example:
  $10,000 in educational expenses(including room & board which is only qualified for the 1099-Q)

   -$3000 paid by tax free scholarship***

   -$4000 used to claim the American Opportunity credit

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

Box 1 of the 1099-Q is $5000

Box 2 is $2800

3000/5000=60% of the earnings are tax free; 40% are taxable

40% x 2800= $1120

There is  $1120 of taxable income (on the recipient’s return)

**Alternatively; you can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip!  When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.

On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 

***Another alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit. Most people come out better having the scholarship taxable before the 529 earnings. A student, with no other income, can have up to $14,600 of taxable scholarship (in 2024) and still pay no income tax. 

[magdalynaa]

Thank you. I'm still having some trouble understanding the best course of action for allocating these expenses. We want to maximize AOTC.

1. The student is the beneficiary and recipient. The 1099-Q came in her name. We planned to add it to her taxes, and the 1098-T to ours since we are claiming her as a dependent.

2. The 1099-Q for the 529 distribution has: Box 1 - $1,134. Box 2 - 0; Box 3 - $1,134. There were no earnings.

3. I'm trying to make sure I don't double dip, but I'm confused. We planned to use the entire $1,134 529 distribution for the $3,040 room and board (with $1,906 in room and board left over). We wouldn't claim that $1,134 towards the AOTC because I didn't think you could use room and board expenses for AOTC? 

4. Once I add up tuition and fees, deduct the restricted scholarships, and add books/supplies, there are $3,799 ACTUAL qualified education expenses. That is $201 less than the maximum of $4,000 for AOTC. Is that $3,799 all I should claim towards the AOTC? We won't quite get the full credit of $2,500, but that's okay. It's close enough, and I just want to be sure I'm asking for the maximum legal credit.

5. If I put $3,799 of expenses towards the AOTC, does that also mean she should have $3,799 removed from unrestricted scholarships and grants received, and claimed as taxable income? That would still put her total income around $10,000 with her job, so she wouldn't owe taxes (I don't think?). Again, trying to make sure I don't double dip.

6. Does it matter that I didn't actually pay $1,134 to University A for room and board all at once, as long as I have enough room and board expenses at the end of 2024 to account for the $1,134 listed on her 1099-Q?

7. She received an unexpected grant of $785 at University A. It was supposed to cover two quarters in 2023, and one quarter in 2024 (so $261 per quarter, with only one quarter in this tax period). We didn't know she was getting it until June 2024, and I wasn't sure what to do with the grant, so I put the whole $785 grant into her 529 plan. How do I account for that grant in these calculations? The 1099-Q doesn't spell it out, but I read over her 529 plan disbursement records. The 1099-Q does take into account that the $785 grant was deposited into her 529 plan. I just don't know how to make this make sense on our tax return. 

So what I thought I should do was (1) claim $3,799 in actual qualified expenses for AOTC (2) take $3,799 from tax-free scholarships and grants and make that $3,799 taxable income instead (3) use $1,134 in 529 distribution for room and board with $1,096 left over that I'm not sure what to do with (if anything).

Or is that wrong? Is there a more financially sound way to allocate this money to get the maximum legal AOTC? 

[Hal_Al]

Forget the 1099-Q. For 2 reasons: if box 2 is 0, there is nothing to be taxed. Furthermore, it's obvious that there was enough room and board to cove the $1134.  DO NOT ENTER IT.

The 1099-Q is  only an informational document. The numbers on it are not required to be entered onto your (or your student's) tax return.

On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 

Q.  Once I add up tuition and fees, deduct the restricted scholarships, and add books/supplies, there are $3,799 ACTUAL qualified education expenses. That is $201 less than the maximum of $4,000 for AOTC. Is that $3,799 all I should claim towards the AOTC?

A. Yes, that is your total qualified expenses.  The AOTC is 100% of the first $2000 of expenses and 25% of the 2nd $2000.  You do the math. 

Q.  If I put $3,799 of expenses towards the AOTC, does that also mean she should have $3,799 removed from unrestricted scholarships and grants received, and claimed as taxable income? 

A. Yes, but not exactly. You count only the scholarships, including the Pell Grant. You do not count the loans, subsidized or not. I counted $2067 in scholarships. 

Q.  That would still put her total income around $10,000 with her job, so she wouldn't owe taxes (I don't think?). 

A. Correct. Technically she isn't required to file. You may want to anyway to document the reporting of scholarship income. 

Q. Does it matter that I didn't actually pay $1,134 to University A for room and board all at once,  as long as I have enough room and board expenses at the end of 2024 to account for the $1,134 listed on her 1099-Q?

A. It does not matter. But, it's now moot (see above).

Q. The 1099-Q does take into account that the $785 grant was deposited into her 529 plan. I just don't know how to make this make sense on our tax return. 

A. There is nothing to report on your tax return, about that.  You received $785 in scholarship. You made a $785 contribution to your 529. In your mind, they're related. They're not.  They're two separate events.  

Q. Or is that wrong? Is there a more financially sound way to allocate this money to get the maximum legal AOTC? 

A. No. You nailed the basic idea. There's just some minor manipulation of the numbers. 

Q. What to do the  left over room and board with $1,096?

A. Nothing R&B are only qualified for a 529 distribution. 

Q.   We think claiming her as a dependent will be more financially beneficial for us (parents) than for her to claim herself?

A. Yes.  But it was never optional. She cannot claim herself and she is not eligible for the AOTC, even if she could. 

[magdalynaa]

This is such a helpful response. Thank you so much!