Claiming AOTC with scholarships +529 distributions

[Dan_2022]

I’ve been working to amend our children’s 2018 tax returns so we can claim the AOTC that we missed that year. I now understand that we can have our children claim partial scholarship or 529 funds as income in order to claim the credit. I’m a little stumped how to make the changes to my daughter’s return as we used a combination of scholarships and 529 funds and could use some help.

The 1098-T from her school reads box 1: $13502; box 5: $12695

The 1099-Q is in our daughter's name. 1099-Q box 1: $4544

Total educational expenses: $17370

     tuition & fees: $13502

     books: $388

     room & board $3480

From her 529, we took out just short of the amount needed to cover her educational expenses minus her scholarships. We paid $131 out-of-pocket. Daughter had ~$7500 in earned income from summer jobs for that year as well.

One of her scholarships was a Pell grant and the terms for the others state that the financial aid awarded can be used for payment of tuition, books, housing costs, transportation, and other related educational expenses.

So, I’m not sure how to go about claiming the AOTC. Do I just have her claim $4000 of the scholarship as taxable income? Or does she have to claim the 529 distributions we used to pay for tuition and fees not covered by the scholarship, and then claim a smaller percentage of the scholarship to make up the difference? And depending on the answer, where should this information entered in TurboTax? I found a screen that asks, "Did you pay for room & board with a scholarship or grant?" and also one at the end of the Education section that asks for the "Amount used to calculate education credit."

I read in a past post that you want to report scholarship as taxable income over 529 distributions as it is treated as earned income, for purposes of the standard deduction calculation. I’ve been looking at this stuff for hours and just keep getting more confused. If anyone can offer some guidance, it would be greatly appreciated!

[KrisD15]

The numbers tell me the student would need to claim 3,869 for you to have 4,000 for the American Opportunity Tax Credit. 

Remember the credit can only be claimed 4 times in regard to this student.

17,370 expenses - 4,000 needed for credit = 13,370 expenses left over

Scholarship 12,695 + Distribution 4544 = 17,239 aid

aid 17,239 - left over expenses 13,370 = 3,869 the student claims as income.

Whether Scholarship or distribution depends. 

Scholarships are reported as Earned Income whereas distributions are not,

ADDITIONALLY, distributions are only taxed on the portion attributed to "EARNINGS". 

If the student only earned 7,500 that year, chances are there will be no additional tax either way. 

[Dan_2022]

Thank you so much for the help! Yes, I agree that $3,869 the student claims as income. That's the $4000 - $131 we paid out-of-pocket.

"Whether Scholarship or distribution depends."

So if I want to claim $3,869 of the Scholarships as Earned Income, how and where would I enter that into TurboTax? Is it at the screen that asks, "Did you pay for room & board with a scholarship or grant?"

And if I want to claim $3,869 of the distributions "EARNINGS" how and where would I enter that into TurboTax? Is this entered at the end of the Education section that asks for the "Amount used to calculate education credit?" It's not really clear to me what happens when you enter in a number at "Amount used to calculate education credit."

I can enter both to see what happens with her taxes, but I just want to make sure I'm entering it correctly. Thanks so much for your assistance!!

[AmyC]

One way is to have your daughter enter the 1099-Q on her return and limit the amount used for qualified expenses to $675 so the rest is included in income. Her income is low enough, there won't be a tax.

Another way, 

1. go to the federal income section
2. scroll to the bottom
3. Miscellaneous Income, 1099-A, 1099-C, Start
4. Scroll to the bottom
5. Other reportable income, Start
6. Other taxable income?
7. Select YES
8. Description taxable scholarship
9. Amount, enter your amount, $3869
10. continue

[Dan_2022]

The 1099-Q is already entered from when the taxes were done in 2018. I can access it in Form View but cannot edit the amounts for “Qualified Higher Education Expenses applied.” Would I have to delete and re-enter the 1099-Q?

I did try entering $3,869 at the end of the Education section when it asks for the "Amount used to calculate education credit?"

After that, TurboTax created Form 5329 Additional Taxes on Qualified Plans with the following:

line 5: Distributions included in income from a Coverdale ESA, a QTP, or an ABLE acct $555

     C Included because beneficiary received tax-free scholarship or other assistance: $425

     E Included only because qualified expenses were taken into account in determining AOTC: $130

line 6: Distributions included on one 5 that are not subject to the additional tax: $555

line 6: Amount subject to additional tax: $0

line 8: additional tax: $0

Does this look correct? Or should I go back and re-enter the 1099-Q?

Thanks again for all the help!

[AmyC]

The amount to calculate education credit should be $4k looking at what  @KrisD did above. I did not realize the 1098-T and 1099-Q were both going on child's return. So often, the parent is the one getting the credit. As long as the correct income is being taxed and there is no penalty, the entries above are fine. Especially since her income is so low, however, she won't have a tax liability and so the education credit will not matter on her return. I just assumed you were claiming her due to her low income. I thought you were taking the credit. I thought she would take the Q and you would take the T. Are you sure you can't claim her and the credit? Please  review the IRS Worksheet for Determining Support. and go through the quick quiz Whom May I Claim as a Dependent?

[Dan_2022]

We (parents) are claiming her on our taxes with her as a dependent and also claiming the AOTC. I am amending her taxes because she has to claim some of her scholarships and/or 529 distributions as taxable if we (parents) are to claim the full $2500 AOTC. Should the 1098-T and 1099-Q not be entered on her taxes at all? 

[Dan_2022]

We (parents) have already amended our 2018 taxes and included the AOTC for the full $2500. I am now trying to see what needs to be amended on my daughter's 2018 taxes since we are claiming $4000. Somewhere we need to indicate that she is making $4000 of her scholarships or 529 distributions taxable. If it doesn't change her taxes due, that would be great, but I'm trying to figure out the easiest and most beneficial way to do that on her amended return. The program does ask you to enter the 1098-T and 1099-Q and prompts that since she is a dependent she isn't eligible for the AOTC. Should I not enter these forms and simply enter the amount of taxable scholarship on 1040 line 1? My numbers are:

13502 Tuition

+388 Books

=13890 Qualified expenses for tuition credit and scholarships

-4000 Used for AOTC

=9890  Allocated to Scholarship 

12695 Total Scholarships

= $ 2805 Taxable scholarship to be reported on student's return

[KrisD15]

You can add the scholarship following these steps:

The distribution is a bit more difficult to compute because of the earnings. 

I suggest you enter the scholarship. 

If that results in tax, try the distribution instead. 

You should be able to enter the 1099-Q, then report all used for education purposes except 2805.  So in your case 1,739 for education expenses. 

TO ENTER THE SCHOLRSHIP AS INCOME ON THE STUDENT'S RETURN:

 Click on Wages & Income

(If the program asks about your W2, select Skip for now )

Select answers to the following questions if necessary to move forward 

Click Add more income 

Scroll down to the VERY LAST option "Less Common Income" and click Show more

On this new drop-down list scroll down to the VERY LAST option "Miscellaneous Income" and click START 

On this new drop-down list scroll to the VERY FIRST option "Other income not already reported on a Form W-2 or Form 1099"

Click START

Select YES to the page titled "Other Wages Received" and Continue

Select CONTINUE on the "Wages earned as a Household Employee" screen (enter nothing here)

Select CONTINUE on the "Sick or Disability Pay" screen (enter nothing here)

Select "Yes" on the "Any Other Earned Income" screen and continue

Select "Other" on the "Enter Source of Other Earned Income" and Continue

In Description Box type "SCH" and the amount 2805

[Dan_2022]

Thanks for sticking with me on this confusing topic! I really appreciate the assistance!

I was able to successfully include the scholarship in her income and add "SCH" and the amount 2805 to line 1 of her 1040. As you stated, her AGI went up but her taxes did not change because she is still under the threshold. I assume I still need to send in her amended taxes to show she is claiming the scholarship money to back up the AOTC claim on our amended return even though her taxes did not change? She did file taxes in 2018 because her summer employer withheld taxes for some reason and she just free filed and received a full refund. Her state taxes did go up a little with the increased AGI so I'd probably need to amend her state return.

One last question: Are my numbers above to claim the scholarship amount of $2805 as income correct? Do I have to account for the fact that $1064 (distributions $4544 - room & board $3480) of the 529 was applied to the tuition bill in my figures? Or are we just dealing with the $12695 scholarship here? I just want to make sure I'm doing the math correctly before mailing these out.

[KrisD15 · Accepted solution]

If her Federal tax liability did not change, you do not file an amended return for your daughter. If the state tax went up, you will need to file an amended State return. 

As far as the numbers, I follow the 2805 Scholarship, but what about the distribution? If you took 4,544 from the 529 plan, but used it for only 3480 room and board, what happened to the additional 1064 distribution amount? 

The earnings on that portion would be taxable for the student if the 1099-Q was issued in her name. 

The calculation is a bit complicated, which is why I suggested entering 3,869 scholarship income on the student's return, HOWEVER your program generated 555 for the distribution, so enter that on the student's return in addition to the 2,805 scholarship income

2,805 goes to her 1040 line 1 HOWEVER the 555 distribution goes to line 8. 

If this changes her tax liability, file the amended return. If it doesn't, just keep everything together with your tax files. 

Enter the 555 on the students return:

Return to the income section

Scroll down to the VERY LAST option "Less Common Income" and click Show more

On this new drop-down list scroll down to the VERY LAST option "Miscellaneous Income" and click REVISIT

Now scroll down to the VERY LAST option "Other reportable income" and click Start

Select YES on the "Any Other Taxable Income?" screen 

Type "Taxable 529 distribution" and the amount 555.

Although the difference was 1,064, you are only taxed on the earnings, so part of the 1,064 was a return of your contribution and 555 is the earnings. 

[Dan_2022]

Sorry for the late reply! I couldn't get back to this return until today. Thank you so much for another detailed response!

Thanks to you and others from past posts on this forum, I think I have finally wrapped my head around all this. After looking back at your first response and the 3,869 number, I understood that anything that was not paid out-of-pocket has to be taxable to add up to the $4000 claimed for the AOTC. After playing around with 3,869 taxable scholarship vs. split between 529 and scholarship, it's clear that claiming the full amount as taxable scholarship is the best route to go since it's calculated as earned income and her taxes due still do not change. I will need to file an amended state return, but taxes are minimal even with interest and penalties.

For any parents dealing with this in the future, it really pays to spend time to understand the underlying formulas to determine taxable earnings on the 529 withdrawals and the tax ramifications of claiming taxable scholarships (earned income) vs taxable 529 distributions (unearned income). Overall TurboTax does a good job, but when you get to these more complex education situations it's a little bit too dumbed down in my opinion. Some of the questions are a bit vague or confusing and they can really have an impact on your taxes if you don't know exactly what the numbers should be. I learned from this forum that there are various ways you can enter your 1099-Q and 1098-T data and you really have to look at the underlying forms as you make changes. Once I knew the funds I wanted to claim as taxable, I needed to check the forms to make sure what I entered on the front end of TurboTax reflected what I wanted on the tax forms. Specifically, you're dealing with taxable scholarship amounts being reflected on line 1 of the 1040 tagged with "SCH xxx" to indicate the amount of scholarship claimed, Form 5329 which shows taxes on earnings from 529 distributions, and possibly Form 8615 which calculates the kiddie tax for any unearned income taxed at the parent's marginal income tax rate.

I would be nice if the government could find a way to just give these credits to those families that qualify rather than require all the mental gymnastics. I know it's an optional credit, but I can't think of a scenario where a family or student that were eligible would NOT want to claim these tax credits.

Good luck to other parents jumping through these tax hoops. Make sure you have a stiff drink on hand for when you are finished!

[KrisD15]

Yes

Scholarship income is reported as "earned income" where the distribution is Unearned.

Once Unearned income for a Dependent passes $350, there will most likely be tax generated. 

Besides the combination of expenses and payments, the American Opportunity Tax Credit may only be used four times per student, so payments made in December might be better to be made in January of the following year. 

Pre-planning can pay off.