excess withdrawal on multiple 529s for American Opportunity Credit -- allocation

[user17749907019]

I have a 529 with my daughter as a beneficiary, and my daughter also has her own 529 with herself as the beneficiary. In 2025, we withdrew enough from the 529 to exactly match all the educational expenses, because there were reasons I thought we wouldn't want to claim the American Opportunity credit this year. However, now I do want to claim the credit, so I apportioned $4000 for the credit, which makes part of the $4000 taxable. My daughter will have to file taxes, but since she's our dependent and she has enough income, her marginal rate will be the same as ours (kiddie tax). 

My question is about the allocation of the $4000 among the two 529s. Are we allowed to choose how it is allocated? For example, my daughter's 529 withdrawal has a lower percentage that is earnings, so if we could choose to allocate the entire $4000 to her withdrawal, we would overall pay less tax on it. However, I'm the one claiming the credit on my taxes. TurboTax (desktop) seems to be spreading the $4000 across the two 529s according to the percentages of the expenses that were paid from each source. If we are allowed to change it, how would I get TurboTax to make that change? Thank you!

[AmyC · Accepted solution]

Yes, you can  choose how it is allocated. However, you will have to do a little math. Understand the 1098-T is an informational form and not considered an accurate tax form. The 1099-Q is accurate but the IRS does not want to deal with it unless taxed.

Since one 1099-Q went completely to qualified expenses, you will need to leave it out to tax the correct form. IRS Publication 970, Tax Benefits for Education states that nontaxable distributions should not be entered.

You can enter the 1099-Q that you want to be taxable. Removed the room and board costs along with other educational expenses were covered by the 1099-Q not used.

For example:

• 1099-Q #1 $15,000 covered room and board and $1k of education expenses
• 1099-Q #2 $20,000 covered tuition

Steps to take:

1. Do not enter 1099-Q #1 since it is not taxable and is not the one you want to make taxable. Tuck it in your tax folder.
2. Enter 1099-Q #2 first.
3. Next, enter 1098-T. with alterations. Since Box 1 tuition had $1k covered by other Q, subtract $1k from box 1. Do not enter room and board since already covered by other Q. 
4. Enter the remaining information for you to claim $4k as education expenses and $4k taxable.

[Hal_Al]

Q. My question is about the allocation of the $4000 among the two 529s. Are we allowed to choose how it is allocated? 

A. Yes, effectively.  Normally, you can allocate expenses anywhere you want. But, that $4000 is not eally  being allocated to 529s. It is being allocated to the American Opportunity Credit (AOC),  being claimed on your return. 

Q. TurboTax (desktop) seems to be spreading the $4000 across the two 529s according to the percentages of the expenses that were paid from each source. If we are allowed to change it, how would I get TurboTax to make that change?

A. You’ll need to use  workarounds on both returns

On your return, your total expenses entered should be $4000 more than your distribution. When you claim the AOC, the net qualifying expenses will equal your distribution. Nothing is taxable.

But, I like @AmyC ’s suggestion better: just don’t enter the 1099-Q since you know it’s not taxable. Just enter the 1098-T to claim the AOC

On her return, you need to allocate enough expenses to her 529 so that the NET total amount allocated is $4000 less than her distribution. But, at the same time you want to claim the penalty exception, for the AOC being claimed on the parent’s return.   So, you’re going to have to make what may appear to be a duplicate  entry of the $4000 (but effectively isn’t). A workaround is needed.

Enter the 1099-Q. When asked who the beneficiary is answer: someone else  (lying to TurboTax to get it to do what you want does not constitute lying to the IRS).  Enter the student's name when asked.  A few screens later, you'll get one simple screen to enter expenses. Press continue at the 1099-Q summary screen, to get the non dependent student summary screen . Click the edit pencil to get the expenses screens. Also enter  $4000 in the box "Tax-free assistance".  This reports a percentage of the  earnings as taxable but claims the tuition credit exception. You do not have to deal with the complicated “Educational expenses and Scholarships” (1098-T) section later. TT will prepare form 5329 to claim the penalty exception.

[user17749907019]

Thank you! This worked for me. Just to be clear for others in the future, I used the amount of the 1099-Q #2 in the example as the tuition amount in the 1098-T, and we included the 1098-T information for both my and my daughter's tax returns. The 1099-Q #2 was entered into both as well. Then I indicated that $4000 was to be used for the credit, on both returns. Because I'd already been adding things in trying to get it to work before, this amount was already set in the form in my daughter's return, but there is a space in forms view where you can set it, even if you can't find it on step-by-step. I didn't need to mess around with anything else.