How to handle 1099Q for dependent child if Parent's AGI is too high for the tuition or education credits

[SandyOH]

We have received a 1098-T and 1099Q for our dependent son. We do not qualify for the tuition deduction or any education credits due to AGI being too high although we have entered all information from his 1098-T as well as education expenses(computer, etc)on our return. Our son used a 529 to pay for qualified expenses. His funds were sent directly to his school and he is the beneficiary.  When completing his return if I answer "Yes" on the 529 question and provide the dollar amount of the distribution tax is being calculated on it. In addition, I am getting a message that although he is claimed by his parents he should enter education expenses to try to offset the distribution. The distribution went completely to qualified education expenses. Should I answer "No" for the 529 even though he had one?  Here are some numbers:

1098-T Box 1 $18,346  Box 5(scholarships) $8,000

1099Q Box 1 $6,491; Box 2 $1,841; Box 3 $4,650

[LenaH]

No, do not change your entry and answer to the 529 question. You should not be taxed on the earnings for your 529 plan since it is a qualified distribution. Entering education expenses and a distribution from a 529 plan is a two step process. From your question, it seems as if you entered both sides, but if you are being taxed on it, something was entered erroneously. 

Please follow the instruction below and make sure everything below is entered. 

First, you must look at the 1098-T input. To do so, please follow these instructions:

1. Open your return in TurboTax.
2. Search for 1098-T with the magnifying glass tool at the top of the page.
3. Click the Jump to 1098-T link at the top of the search results.
4. Click edit next to the 1098-T. 
5. Enter the information as shown on the 1098-T, including all education expenses. 
6. Scroll down on the screen Did you Pay for Books or Materials to attend school? and you should see a question about whether you took a 529 distribution. Enter yes for this question. 
7. Follow the on-screen instructions to finish entering the1098-T.

Second, enter the information regarding your 529 distribution. To do so, please follow these instructions: 

1. Search for 1099-Q with the magnifying glass tool on the top of the page.
2. Select the Jump to 1099-Q link at the top of the search results.
3. Choose you as the recipient and click continue. 
4. Choose the student's name and click continue. 
5. Follow the on-screen instructions. 

[Hal_Al]

Q. Should I answer "No" for the 529 even though he had one? 

A. Yes.  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." 

If you do enter the 1099-Q, on his return, the message is correct, he should enter education expenses to try to offset the distribution or calculate the taxable portion if he did not have enough expenses.  Enter the 1099-Q first; then the educational expenses. Since he is your dependent, he also cannot claim a tuition credit.

Also don't enter the 1098-T on your return if you know you don't qualify for a credit/deduction and also know that the 1099-Q is going on the student's return.  The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return.  It's OK if you did and TurboTax (TT) correctly concluded that you get no credits. Jus save yourself the hassle next time.

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More than you want to know about  Qualified Tuition Plans  (QTP 529 Plans) distributions

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:
  $10,000 in educational expenses(including room & board)

   -$3000 paid by tax free scholarship***

   -$4000 used to claim the American Opportunity credit

 =$3000 Can be used against the 1099-Q (usually on the student’s return)

Box 1 of the 1099-Q is $5000

Box 2 is $600

3000/5000=60% of the earnings are tax free

60%x600= $360

You have $240 of taxable income (600-360)

**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.

[SandyOH]

Thank you. If I do not enter the 1098-T on my return and I do enter the 1099Q  on his return am I not able to include his tuition as part of his education expenses since he is my dependent? 

[KrisD15 · Accepted solution]

IF the 1099-Q is of no consequence, since it was all used to pay tuition, you needn't enter it into the TurboTax program. Keep a copy of the 1099-Q along with tuition receipts with your (and the student's) tax files.  

IF the 1098-T is of no consequence, since you can't claim the credit and there is no taxable income generated by it, the 1098-T does not need to be entered into the TurboTax program. Keep it and the student school statement with the tax files. 

There is one other option, the dependent student can claim the education expenses. The credit can offset his tax liability, but it can't increase his refund (it isn't refundable to him).

This can only be done if the Taxpayer that COULD claim the student doesn't. The student also cannot claim himself, he need to still file as a "potential" dependent. He does this by selecting "YES, Someone else can claim me" BUT "NO to Someone else will claim me".

This would only be beneficial if the student has a tax liability and if not claiming the dependent does not negatively affect the parent's return.

[Hal_Al]

KrisD15 is correct, you do not need to enter either the 1099-Q or the 1098-T on either your return or your student's return.  Your son is not eligible for a credit  because he is a dependent.  He does not need to enter the 1099-Q because you have already determined that none of it is taxable. 

Entering those things will have no effect on either return.  But. you run the risk of making an error in what is a complicated process to get to the answer you already know.

[SandyOH]

Thank you so much! I removed him as a dependent  and removed all related education expenses from my return and entered all his education expenses and his 1099Q on his tax return. He did have a higher than usual tax liability since this was a crazy year with remote college and much more time to work. This approach reduced his federal liability and also improved his MA state tax situation.