Confused about why my taxes went up after qualified 529 Distribution

[txmiser]

Before I started my Education expenses my taxes owed were $2518.  I then entered the distribution from the 529 plan where I am the recipient and my son (who doesn't file due to not having a job) is the beneficiary.  The gross distr was approx 27K with 8.7K and earnings and 17.9K basis The college expenses for tuition and books equaled the amount distributed from the 529.  Yet my taxes increased $753 to $3271.  I was under the impression that 529's were tax free earnings as long as it is used for qualified college tuition and books.  So why am I paying more after this section

[MinhT1]

If you have ascertained that qualified education expenses plus room and board of the beneficiary cover the amount of the distribution reported on form 1099-Q, you can just not report the 1099-Q on your tax return at all. You just keep the form in your tax records together with calculations to show that you have enough education expenses and room and board to cover the distribution.

On form 1099-Q, instructions to the recipient read: "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." 

[Hal_Al]

Q. I was under the impression that 529's were tax free earnings as long as it is used for qualified college tuition and books?

A. That's correct. Room and board are also qualified expenses for a 529 distribution.

Q.   So why am I paying more after this section?

A. Because there are many ways to go, with educational tax benefits and TurboTax (TT) doesn't always do a good job. 

But there's a simple solution: just delete the 1099-Q.

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. 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. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. You also cannot count expenses that were paid by tax free scholarships. You cannot double dip! 

References:

1. 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." 
2. IRS Pub 970 states: “Generally, distributions are tax free if they aren't more than the beneficiary's AQEE for the year. Don't report tax-free distributions (including qualifying rollovers) on your tax return”.

[txmiser]

Thank you although things just got corrected.  There were a few other areas for education that I didn't think I needed to enter.  After I got pinged to finish those areas later the amount dropped off back to the original number. All good now.

[randsom]

This is so stupid that we need to ignore entering it because TT is not smart enough to know NOT to raise your taxes from a 1099-Q 529 distribution!

[cheer25]

I did not notice Turbotax had this problem (tax went up after qualified 529 distribution) until I filed my 2023 tax return lasy year.  Now I am wondering how to get those overpaid tax back when I use turbo tax to file my tax return this year?

[Hal_Al]

Q. Now I am wondering how to get those overpaid tax back when I use turbo tax to file my tax return this year?

A. You file an amended 2023 tax return. 

How to amend 

https://ttlc.intuit.com/turbotax-support/en-us/help-article/tax-return/amend-change-correct-return-a...

More info

https://turbotax.intuit.com/tax-tips/amend-return/how-to-correct-federal-tax-returns/L67t0F7il

[cheer25]

Thanks to Hal_AI's response.  I have a couple of more questions for the amendment.

1. My overpaid tax for 1099-Q happened in my 2022 Tax return, so I need to open my 2022 Turbotax download to do an amendment. Is that correct?

 2. According to Hal_AI's provided link about amending tax returns. It says "Under Need to Amend a Filed Return?, select Amend a Filed Return." Somehow I could not find it from my 2022 Turbotax download. Does anyone know where it is?

[Hal_Al]

@cheer25 

You should ask a fresh question /open a new thread on the amend question (new subject) to get more experts to see it.

[Dgyp]

OMG! You have to be kidding me!

This is a serious problem, I ran into the same thing every year - to the point I was arguing with someone about 529s being tax-deferred and not tax-free.  I found that I was WRONG and then found this thread because again, I'm filling out the form using Home & Business and sure enough, it adds significantly to my tax bill after I finish the 529.

I see NOWHERE in Turbo Tax telling me I shouldn't put it in if they are qualified, which they are.  You have to be KIDDING me.  Why isn't there a button "did you use all of these funds for qualified education expenses?" - and if you click "yes", it doesn't add to the tax.  OR ask me "what it

Lifetime user of TurboTax and I just lost complete faith in the product.  Now I need to go back over the last 3-years and figure out if I paid too much and if so, file a correction?  What a waste of time and money.

Please tell me I am not understanding?

[Hal_Al]

Q. Please tell me I am not understanding?

A. TT is aware of the problem. But, I haven't actually heard that they are going to address it.

I surmise (they haven't actually said it) that one of the reasons is that users may lose out on the tuition credit if they think everything has already been covered by the 529 distribution. If you enter the 1099-Q and later enter the 1098-T and do everything right, and you don't have enough expenses for both the 529 distribution and the tuition credit,  TT will give you a screen (Maximize my education benefit)  where you can re-allocate some tuition from the 1099-Q to the Tuition credit. It will pre-populate the box with the suggested amount.  It does a good job, but you have to "do everything right".

[Dgyp]

Thank you for your thoughtful reply, I guess it gives me some solace or something like that.

i tried deleting the 1099q/1098t and starting with the 1098, plus adding in the other expenses as “required”… rent is the big one,  it shows the expenses as far more than the 1099q distribution but is still “taxing me” (amount owed goes up).  I’m giving up, I’ll just leave both out altogether… I know my qualified expenses  exceeded the distributions so I can survive an audit but still very disappointed with TurboTax’s handling of what has to be a common use case… I’ll move on!

cheers, and thanks again