Although the general rule for educational benefits is that the parent must be claiming the student, as a dependent, to get the benefit, the 529 plan is an exception. You and your spouse may file as Married Filing Jointly and Mom can still claim the 529 plan earnings exclusion.
As for the details, it's complicated.
For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student, who may or may not be a 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 parent's return (I assume), the 1098-T maybe should go on the student's return (in your case), so you can claim the education credit. This assumes Mom is not in the 22% (or higher) tax bracket. The Lifetime Learning Credit (LLC)is worth 20%, to you, if you have a tax liability. Grad students are not eligible for the more generous American Opportunity credit (AOC)
You can and should claim the tuition credit before Mom claims the 529 plan earnings exclusion. The educational expenses Mom claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit. This takes some coordination between you.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit, that gets her 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.
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 LLC
=$3000 Can be used against the 1099-Q (usually on the student’s return, but could be either)
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.
