How to generate an American Opportunity Tax Credit by declaring $4,000 of 529 money as taxable. 1099-T, 1099-Q, AOTC

[Haven2025]

Hello!

I am again so confused in Turbo Tax with AOTC and 529 issues related to realizing the maximum Education Credit for my daughter. We have spent countless hours trying to figure this out with a straightforward approach along with attempting a workaround solution. Hoping you all can help once again. 

Here’s some basic info:

My daughter graduated from a 4-yr college in Spring of 2023.

She is filing Single and is not a claimed dependent by anyone

Only two previous AOTC claims

Her income amount is within the guidelines.

Scholarship/Grant is not taxable and not restricted to tuition expenses.

My daughter is the recipient in the 1098-T and 1099-Q 

1098-T

Box 1 - $10,066

Box 5 - $10,066

Box 2,3,4,6 $0

1099-Q

Box 1 - $9,800.00

Box 2 - $7,533.09

Box 3 - $2,266.91

1098-T - is entered in Turbo Tax

1099-Q - is currently NOT  entered in Turbo Tax as I’m told it is not necessary if  amount distributed equals qualified expense. I also find that entries are confusing for Education Credits and the calculations results seem so inconsistant when1099-Q info is entered in Turbo Tax

My understanding is that in order to generate an AOTC credit, we need to declare $4,000 of 529 money as taxable. I followed the calculation formula from previous posts and calculated taxable income as follows.

$19,866 in education expenses(including room & board)

-$10,066 paid by tax free scholarship

-4,000 used to claim the AOTC

$5,800 can be used against the 1099-Q

Box 1 of the 1099-Q is $9,800

Box 2 is 7,533

5,800/9,800 = 59.18% of the earnings are tax free, 40.82% are taxable

0.408 x 7533 = $3,073 Taxable Income to Report*

*None subject to the 10% non-qualified distribution penalty because the non qualified portion of distribution was used to claim a credit.

My daughters taxes are extremely easy except for this AOTC Education Credit. Turbo Tax does at this point show a full AOTC credit of $2,500 but in looking at the limited “Federal Summary” I’m not sure it’s all entered correctly and do not see any reference to the $3075 taxable amount. Here’s what I do see:

1.  1040 Line 8 Additional Income from Schedule 1 Line 10.  $4000
2.  1040 Schedule 1, Part1, 8r “Scholarship and Fellowship Grants not reported on FORM W-2”.  $4000
3. In “Tax Tools” “Tools” Delete a Form” ,I do see a FORM 8863 is indicated as part of this tax return.

In one of the Deductions & Credits Prompts it seems unique and new to me so I thought I’d share what I entered…

Did You Pay for Room and Board with a Scholarship or Grant?

Tell us if you used a scholarship, grant or fellowship to pay for room and board or for one of these other expenses: research, travel, clerical help, or equipment. 

Ans: Yes

How much of the $10,066 you received in scholarships, fellowships, and grants was used to pay for this expense?

Ans: $4000

My assumption is that $4000 of 529 money (used to pay R&B) will be taxed to go towards tuition (allowing AOTC credit) and in turn the Grant money would go to pay R&B expenses.

 I feel like this is in some way a work around to get a correct Education Credit for filing, yet I wonder because it seems like the focus should be on creating taxable 529 money.

Any and all help is appreciated! Thank you!!!

[Hal_Al · Accepted solution]

Q. How to generate an American Opportunity Tax Credit by declaring $4,000 of 529 money as taxable?

A. With your numbers, you don't want to do that (allocate expenses  away from the 529 to the AOTC). 

Instead, you allocate expenses away from the scholarship and to the AOTC. And, that is what TurboTax (TT) has correctly (apparently) done. That's why you have $4000 of taxable scholarship income on line 8r of schedule 1. 

You must allocate all room & board (R&B) expenses to the 529 distribution. R&B is a qualified expense for a 529 distribution, but not for tax free scholarship and AOTC. 

$19,866 in education expenses(including room & board)

-$6,066 paid by tax free scholarship

-4,000 used to claim the AOTC

$9,800 can be used against the 1099-Q

So the 1099-Q is tax free.  If TT did it right, there should be no entry on line 8z of schedule1 (that's where taxable 529 earnings go). You should be showing the AOTC on line 3 of schedule 3 ($1500 max) and line 29 of form 1040 ($1000). 

[Haven2025 · Accepted solution]

Hal_Al,

Thanks so much for clarifying things and providing a straight forward detailed answer.  I have a better understanding of the key concept and far more confident that I’ve entered things correctly.

All the best to you!