If I paid for my child's college expenses using a 529 plan, can I still get the education tax credit?

[SweetieJean]

The IRS disallows parents from “double-dipping” or utilizing more than one tax benefit for the same educational expenses. Parents who claim the AOTC for themselves or their child may not receive the full tax exclusion on 529 funds used to pay for college.

[re2boys]

You can receive both tax benefits.....but you can't count the same expense twice. A QTP is a 529 Plan.

If all the college expenses were paid with withdrawals from a 529 Plan, it would be most advantageous to claim the AOTC using the first $4000 in expenses.  This may leave you with up to $4000 of 529 withdrawals as potentially taxable.

From IRS Pub 970, Chapter8:

Coordination With American Opportunity and Lifetime Learning Credits

An American opportunity or lifetime learning credit (education credit) can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses aren't used for both benefits. This means that after the beneficiary reduces qualified education expenses by tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit.

Example 2.

Assume the same facts as in Example 1 , except that Sara's parents claimed an American opportunity credit of $2,500 (based on $4,000 expenses).

 Total qualified education expenses$8,300  Minus: Tax-free educational assistance?3,100  Minus: Expenses taken into account  
in figuring American opportunity credit?4,000  Equals: Adjusted qualified  
education expenses (AQEE)$1,200     

The taxable part of the distribution is figured as follows.

 1.$950 (earnings)×$1,200 AQEE  
$5,300 distribution     = $215 (tax-free earnings) 

 2.$950 (earnings)?$215 (tax-free earnings)  = $735 (taxable earnings)   

Sara must include $735 in income (Form 1040, line 21). This represents distributed earnings not used for adjusted qualified education expenses.

Coordination With Coverdell ESA Distributions

If a designated beneficiary receives distributions from both a QTP and a Coverdell ESA in the same year, and the total of these distributions is more than the beneficiary's adjusted qualified higher education expenses, the expenses must be allocated between the distributions. For purposes of this allocation, disregard any qualified elementary and secondary education expenses.

Example 3.

Assume the same facts as in Example 2 , except that instead of receiving a $5,300 distribution from her QTP, Sara received $4,600 from that account and $700 from her Coverdell ESA. In this case, Sara must allocate her $1,200 of adjusted qualified higher education expenses (AQHEE) between the two distributions.

 $1,200 AQHEE×$700 ESA distribution  
$5,300 total distribution=$158 
AQHEE (ESA) 

 $1,200 AQHEE×$4,600 QTP distribution  
$5,300 total distribution=$1,042 
AQHEE (QTP) 

Sara then figures the taxable portion of her Coverdell ESA distribution based on qualified higher education expenses of $158, and the taxable portion of her QTP distribution based on the other $1,042.

Note.

If you are required to allocate your expenses between Coverdell ESA and QTP distributions, and you have adjusted qualified elementary and secondary education expenses, see the examples in chapter 7 under Coordination With Qualified Tuition Program (QTP) Distributions .

Coordination With Tuition and Fees Deduction

A tuition and fees deduction can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses aren't used for both benefits.

[Hal_Al]

Yes, but it may (probably) result in some of the distribution from the 529 plan being taxable. The 529 plan will send you a form 1099-Q in January.

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 

  Box 1 of the 1099-Q is $5000 (Total distribution)

Box 2 is $600 (Earnings)

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

60%x600= $360

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

[Hal_Al]

For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the 1099-Q can be either the owner or the beneficiary depending on where the money was sent. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient".
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 QTP. 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.

[BigBadBob]

Can you help me with the following question?  Let's use another example of Sara (a senior in college), but assume Sara spends the entire year away from home in another state at college and she contributes more than 50% to her total support (and her parents cannot and do not claim her as a dependent on their taxes).  In previous college years, Sara's expenses were as follows:

$50,000 = Tuition (including room and board)

$30,000 = Merit-Based Scholarship

$20,000 = Remaining Qualified higher education expenses (QHEE)

$10,000 = Sara's income working at college, including during summer away from parent's home.

$2,500 = Sara's contribution to her remaining tuition (QHEE), leaving $7,500 to be paid.

$7,500 = Contribution from Coverdell ESA (and/or 529) which her parent (me) funded

$1,000 = Sara's tax refund (40% of $2500) since Sara owed no taxes & received American opportunity tax credit (AOTC)

$20,000 = Amount remaining in "Sara's" (my) Coverdell ESA (and/or 529) which I want to remove from the plan and put in the bank, given it's no longer needed for college.  This is the same amount as the scholarship she received in her senior year, and I am allowed to remove $20,000 without the 10% penalty.  I will pay income tax on the earnings.  For sake of argument let's assume no earnings, since not key to my question.

My question is as following:

How do I remove the $20,000 this year without negating the ability for Sara to receive the AOTC (i.e. $1000 tax credit refund on her 2020 taxes based on 25% of $2,500)?  Note that it is necessary to have $2,500 (as above) not paid by QTPs (ESA or 529) to get AOTC.  How can we maintain the $2500 not paid by QTP so Sara gets tax credit ($1000 refund) and get the remaining $20,000 out of ESA?

Thanks!

[Hal_Al]

Assuming Sara is under 24, she still cannot claim the AOTC (refundable portion) because she does not provide more than half her support with EARNED INCOME.  It's an additional rule. To not be a dependent, the rule is only that she provided more than half her own support, without regard to the source of the support.

But to answer your question: to keep the 529 withdrawal from being support, you just pay tax on it, instead of claiming you used it for education.   Some penalty may be avoided because some of the QHEE was covered by Scholarship. being away at school, even for the entire year and even living off campus. id still considered only a temporary absence from the parents home. 

But, the information you provided indicates that Sara CAN  be claimed as  a dependent. She has not provided more than half her support.  Scholarships are third party support, not support provided by the student.