I have a question on 529 and using Education tax credits.

[fusecon]

Situation:
Independent son, Half-Time Student. We use his 529 (1099-Q) to pay $1,200 in Tuition (1098-T) and books. The 529 had around $200 in gains. Is it possible for us to use Amer Opp Credit as well? Lot's of people said NO. No double dipping. Running numbers in Turbo tax (1099Q) seems to allow it but you pay taxes on the $200 in 529 gains. What is right way to do this properly?

[ChristinaS · Accepted solution]

You can't do both. If you exclude the gains, you cannot also take the credit using the same numbers.

It sounds like he qualifies for the credit. If that's the case, he is most likely better off paying taxes on the gains and taking the credit. It seems this is occurring.

You are not required to exclude the gains because you have the 529.

Paying tax on $200 in gains likely has a minimal impact (maybe $20-$30 in extra tax). On the contrary, the credit could be saving him $200.

Take the credit.

[fusecon]

The way Turbo Tax seems to handle this (on Form 1040) is the 529 Gain gets added to income on line 21. Education credits gets added back on line 50 and line 68. In the end the savings is closer to about $1k and effective tax rate is negative--he gets back more than he paid in taxes for year because of the credit "payment" on line 68. Seems odd.

[ChristinaS]

If you don't exclude the earnings, you are taxed on them on line 21. He is being taxed on the earning then, so its now taxable income.  He is now using his income towards what he paid for college. The refundable credit is a windfall, no doubt. But what you describe is how it works. You can call it odd, but its not incorrect. In this case, adding taxable income on Line 21 essentially has nothing but a positive impact on his taxes. But, that doesn't mean he doesn't merit this credit.
Its correct.

[fusecon]

Thanks again. I will put my trust in TurboTax on this one. Paying tax on the QTP (529) gains (to avoid the double dip) and getting the credit is definitely the way to go. Doing research on the internet it seems there isn't a clear answer on this topic. It makes since that you shouldn't be penalized by having 529 and without getting the credit that is what would be happening. To simplify, 529 Gains = pay taxes on (Line 21) which pretty much eliminates the tax savings of having this and take the credit. It is too bad this stuff is confusing.