Error in "Adjusted Qualified Higher Education Expenses applied"?

[Anonymous]

I am perceiving a possible error in how TurboTax is calculating the "Adjusted Qualified Higher Education Expenses applied" value on lines 2g and 2h in Part VIII of the Student Info Worksheet for my dependent child's tax return.

In 2020, the college reported on the 1098-T $12,559 in total receipts for my child of which $4,950 was scholarships on the 1098-T.  That results in $7,609 remaining which was paid directly to the university from the child's 529 QTP savings plan.

According to the 1099-Q for the 529 QTP plan, $17,718 was distributed from the plan (with $3,727 being earnings).  Of that $17,718 in distributions, $7,609 was used to pay the aforementioned tuition, and the remainder ($10,109) was used to pay room and board and other expenses.

The child is not eligible for any Education tax credits since the child is in graduate school and we did not attempt to claim them on either my return or the child's return.

TurboTax, however, only considers the $10,109 to be part of the adjusted qualified higher education expenses on lines 2g and 2h of Part VIII of the student worksheet.  The $7609 paid in tuition is not considered there.  I can see on line 17 of Part VI of the worksheet that the $7609 paid in tuition is "used for credit" or deduction.  Why is that the case when we are not attempting to claim the credit.

It does not seem right that the child should have to pay taxes on part of the $3727 in earnings from the 529 proceeds when all the proceeds from the 529 were used to pay either tuition or room and board, both of which are qualified education expenses.

Can someone explain to me what is going on?

[Hal_Al]

The TurboTax interview is complicated.  If you know none of it is taxable, 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. 

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." 

For others reading this, 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! 

[Anonymous]

Thank you, Hal, for the insights and the suggestion.

I am curious, because I am a curious person, why TurboTax insists on designating the $7609 which was paid to the university from the 529 plan as funds which were "Used for credit or deduction" when in fact we did not attempt to use the credit or deduction.  This seems like an error in the program, one which could result in people paying more tax than they needed to.  I suspect most people aren't as willing to dive into the details and question the results of the program like me, which results in them paying more than their fair share.

[Hal_Al]

@Anonymous  said "The child is not eligible for any Education tax credits since the child is in graduate school and we did not attempt to claim them on either my return or the child's return".

Graduate school means the student is not eligible for the more generous American Opportunity Credit.  But he is eligible for the Lifetime Learning Credit (LLC).  If he is your dependent, you claim it on your return.  Your income must be less than $138K (Married filing Jointly) Raised to $180K in 2022.

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 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 even though it was "his" money that paid 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:
  $17,718 in educational expenses(including room & board)

   -$4950 paid by tax free scholarship***

   -$7609 used to claim the LLC

 =$5159  Can be used against the 1099-Q (usually on the student’s return)

Box 1 of the 1099-Q is $17718

Box 2 is $3727

5159/17718 =29% of the earnings are tax free; 71% are taxable

71% x 3727= $2642

You have $2642 of taxable income  

**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. 

Example:

Student declares his $4950 of scholarship as taxable income
  $17,718 in educational expenses(including room & board)

   -$10,000 used to claim the LLC (to get max. $2000 credit)

 =$7,718  Can be used against the 1099-Q (usually on the student’s return)

Box 1 of the 1099-Q is $17718

Box 2 is $3727

7718/17718 =43.6% of the earnings are tax free; 56.4% are taxable

56.4% x 3727= $2103

You have $2103 of taxable income  

So, why have the student report $7053 (4950 + 2103) of income, rather than $2642?  It's complicated.  First there's the additional LLC the parents get (about $478). Scholarships count as "earned income" for  a student-dependent's standard deduction. So, the student has only $1753 (7053-4950 -350) of taxable income vs. $1542 ($2642 - 1100) the other way.  He pays about $25 more tax to get the parents $475.

[Hal_Al]

@Anonymous said "I am curious, because I am a curious person, why TurboTax insists on designating the $7609 which was paid to the university from the 529 plan as funds which were "Used for credit or deduction" when in fact we did not attempt to use the credit or deduction......."

Most people come out ahead claiming the credit and  paying a little tax on the 529 or scholarship money; so TT makes that assumption.  You should reach a  screen titled “Amount Used to Calculate Education Deduction or Credit”, verify the amount you want to use or change it (a lot of users are claiming they're not getting that screen this year.  I've reported the complaint to TT)

This seems like an error in the program, one which could result in people paying more tax than they needed to.  I suspect most people aren't as willing to dive into the details and question the results of the program like me, which results in them paying more than their fair share.

[Anonymous]

Our income is greater than the threshold for the Lifetime Learning Credit, so we did not attempt to claim that tax credit on our return.  It seems like TurboTax is assuming on the child's return that we, as the parents, did actually claim that credit, and there's nothing we can do to change it. 

I did not see the screen you mentioned in your other response.

Every year, we run into some kind of issue with TurboTax with regards to education expenses.  I know it is a confusing area of the rules, so it must be difficult to set the program to work well.

[broy]

I am running into a similar problem.  We don't qualify for any of the tax credits.  

My son attends a 4 year college and has a full scholarship. We took $31,660 out of our 529 plan and have $6,977 of qualified education expenses. We know that the earnings part of the excess $ taken out will be taxable and I am able to calculate  the taxable income. The problem is that on Form 1099 Q worksheet that the adjusted qualified education expenses are only $6,362. Why are the adjusted qualified education expenses $615 less (line 2c of the QTP Computation of Taxable Distribution)?

[Hal_Al]

See the Student Info worksheet for details

[broyston5]

The student info worksheet does not have the calculation. It turns out the $615 is the amount we spent on books for my son. Why are the cost of required books backed out of the qualified higher education expenses. Thanks!

[broyston5]

I found the student worksheet for my son. It does not explain why the $615 of books (books needed for his classes) is backed out of the Qualified Higher Education Expenses. Do you know why? Thanks!

[Hal_Al]

You'll notice that there are several columns on the student info work sheet.  Books are qualified expenses for some tax benefits, but not others.  Some benefits only allow books purchased from the school. 

The $615 should be on line 3 or 4 or 5 of the worksheet. 

If the $615 is not on there somewhere, you did not enter it properly in the TT interview. 

[Rusty24]

I agree. This is a problematic error. It was very hard to figure out how to eliminate the assumption that the parents would be eligible to claim an education credit and therefore would. I finally figured out how to zero out the "claimed credit" on the student worksheet. 

[J141]

I am having the same error with Turbotax 2020. The Easy Step interview NEVER asked for education expenses to be entered. I verified by going back just now to easy step and running through it one more time. 

If not for some of the posts on this site, I would not have figured out that Turbo Tax expects you to enter education expenses by hand in a worksheet. Worse, I am still getting some of the 529 distribution being taxed even though the educational expenses match the 529 distribution. 

I liked the response given by one person that points out that 1099-Q form says that nontaxable distributions need not be reported on the return. So should I just delete the 1099-Q? If so, why does Turbotax ask for it in the interview?  I have never experienced an error like this in Turbotax before. If I had not caught I would have overpaid taxes by THOUSANDS of dollars. 

I saw questions about this problem on this site dated spring 2020. Why has Turbotax let a year go by without fixing this?

Another question: How do we talk to a live Turbotax employee about this? Help Center brings one here where we users seem to be sharing opinions, and the Help tab up top generates quite uninformative statements about the current form you are looking at. Am I missing something about how to speak directly to a Turbotax employee?

[Hal_Al]

To contact TurboTax (TT) support:
https://turbotax.intuit.com/support/contact/index.jsp 

In the search line enter some keywords or question without quotes. On the next page, skip the suggested topic links and scroll down until you see CALL US.  It should show the wait times.    Free support is not available to Free Edition users. You will have to upgrade to talk to a representative.

Live help is available 7 days per week from 5:00 a.m. to 9:00 p.m. PST. (Jan 11- May 21+/-)

[sspuler]

Thanks for this insight.   By answering the interview questions and entering the tax forms I had (1098-T and 1099-Q) 2022 TurboTax wrongly calculates that a 529 distribution is in excess of college expenses – causing a substantial excess tax payment.   The workaround requires setting the tax credit to $0 in the forms (Student Info Wk, Part VI, line 17 'used for credit').