Excluding bond interest for education expenses

[StinkinBadger]

We cashed in a couple of I Bonds in 2024 and I'm trying to determine if I can exclude some of the interest because of paying college expenses for my son.  Here's the details (figures rounded for simplicity)...

A) Tuition and fees for 2024 = $17,000

B) Room and board for 2024 = $12,000

C) 529 Distributions during 2024 = $21,000 (used to pay for some of both tuition costs and room/board costs)

D) 529 Contributions during 2024 = $5,000

E) I Bonds cashed out in 2024 = $23,000 ($20,000 principal + $3000 interest)

F) Need to pay for at least $4000 in qualified higher ed expenses out of our pocket to qualify for $2500 American Opportunity tax credit (AOTC).

On Form 8815:

* Entry for Line 2 is for "total qualified higher education expenses you paid in 2024".  The instructions indicate that this can include "qualified higher education expenses" as well as contributions to a QTP (i.e. 529)... but that it cannot include expenses for "room and board", expenses used to figure a credit on Form 8863 (for the AOTC), and expenses used to figure out the nontaxable amount of a distribution from a QTP.

Given this, it looks like this can include:

$17,000 in Tuition and Fees + $5000 in 529 Contributions. 

LESS $4000 used to figure the AOTC credit.

This drops the total on Line 2 down to $18,000.

* Entry for Line 3 is for "total of any nontaxable educational benefits received for 2024".  The instructions indicate that these benefits include "Payments, waivers, or reimbursements of educational expenses under a QTP."

I am a bit uncertain what should be included in Line 3.  Specifically how much of the $21,000 in 529 distributions we received in 2024 should I include.  I think the 2 options are:

A) Include the entire $21,000 in 529 distributions that we received in 2024... which would mean that we are ineligible for the higher ed exclusion (because $21,000 is greater than the $18,000 on Line 2).

B) Include only the portion of the 529 distributions that went toward qualified higher education expenses as defined in the instructions for Form 8815 (tuition and fees... but not room and board).  Under this option, we would enter $9000 on Line 3... which would mean that we would be eligible for the higher ed inclusion.  

Here's the breakout of costs and payments for this option:

• Tuition and Fee Costs ($17,000):
  • $8000 out of pocket
  • $9000 from 529 distributions
• Room and Board Costs ($12,000)
  • $12,000 from 529 distribution

Given all this, I guess my questions are:

1) Am I off the mark in any of my understanding of the rules surrounding taxes and college funding?

2) If not, which option should I follow when completing Form 8815?

Thanks for any help you can provide!

[StinkinBadger]

After re-reading my post, I think I need to make one clarification regarding the cost and payment breakout I provided.  Here goes...

B) Include only the portion of the 529 distributions that went toward qualified higher education expenses as defined in the instructions for Form 8815 (tuition and fees... but not room and board).  Under this option, we would enter $9000 on Line 3... which would mean that we would be eligible for the higher ed inclusion.  

Here's the breakout of costs and payments for this option:

• Tuition and Fee Costs ($17,000):
  • $8000 $4000 out of pocket
  • $4000 from I Bond sale
  • $9000 from 529 distributions
• Room and Board Costs ($12,000)
  • $12,000 from 529 distribution

[Hal_Al]

You can roll over U.S. savings bonds into a 529 college savings plan by redeeming the bonds and depositing the proceeds into the 529 plan within 60 days. This is considered equivalent to using the proceeds for qualified education expenses.  I'll assume you meet that rule. 

Don't enter anything on line 3 of form 8815 because you have already decided that the amount on line 2 is what you want to claim for the savings bond exclusion. Any additional adjustment will come when you allocate expenses to the 529 distribution (if needed and they're not).  The amount of the 529 distribution is irrelevant for the savings bond exclusion.  What's relevant is what expenses you are going to allocate to the 529 distribution. You've decided only Room & board will go to the 529.  So, there's no overlap of expenses to the bonds and the 529.  No adjustment to expenses (on line 3 of form 8815) is needed. 

So, that leaves $12,000 of Room and board, as the only expenses,  for the 529 distribution. Unless you have some books and a computer to add.  12000 expenses / 21000 distribution = 0.57;  57% of the earning shown in box 2 of the 1099-Q are tax free. 43% are taxable.  Most of it will also be subject to the 10% non qualified distribution penalty.  Using $4000 of expenses, for the AOTC, is a partial penalty exception.

Here's the hard part of all this: Since some of both the savings bond interest and the 529 earnings will be taxable, it's it better to allocate more tuition to the bonds or the 529?  I suspect that comparison may be easier to calculate by hand then in TT. 

Does your student have any scholarships in box 5 of the 1098-T?  

[StinkinBadger]

Thanks for taking a crack at this.  A couple of follow-ups...

1) No scholarships in Box 5 on the 1098-T

2) My thought was that the $21,000 in 529 withdrawals would go to a combination of tuition (9000) and room/board (12,000).  This would keep things clean and no taxes would be owed on the 529 withdrawals.  It would then leave $8000 of tuition costs to be split between part of the I-bond withdrawal ($4000) and savings ($4000... need this to qualify for AOTC).  So a portion of the I-bond withdrawal will be taxable... but at least some of it would get excluded.

Again, thanks for your input!