My daughter received a scholarship. I took a 529 withdrawl for that same amount. How do I file this to avoid penalties?

[Hal_Al]

You don't say what her expenses were.  The implication is that it was a full ride scholarship.  In TurboTax (TT), you enter the 1099-Q first. Then you enter the 1098-T and other expenses in the Educational expenses section.  TT sees that expenses were covered by scholarship as well as the 529 distribution and prepares form 5329 to claim the penalty exception.  Even if it's not a full ride scholarship, you do it like that and TT will calculate the taxable portion.  It's even possible to claim a tuition credit by paying a little more tax on the 529 distribution or declaring some of the scholarship income taxable.  

Provide the following info for more specific help:

• Are you the student or parent.
• Is the  student  the parent's dependent.
• Box 1 of the 1098-T
• box 5 of the 1098-T
• Any other scholarships not shown in box 5
• Does box 5 include any of the 529/ESA plan payments (it should not)
• Is any of the Scholarship restricted; i.e. it must be used for tuition
• Box 1 of the 1099-Q
• Box 2 of the 1098-Q
• Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)?
• Room & board paid. If student lives off campus, what is school's R&B charge. If the student lives at home, only the school's board charge for on campus students. 
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers
• How much taxable income does the student have, from what sources
• Are you trying to claim the tuition credit (are you eligible)?
• Is the student an undergrad or grad student?

____________________________________________________________________________________

Qualified Tuition Plans  (QTP 529 Plans) Distributions

General Discussion

It’s complicated.

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 $2800

3000/5000=60% of the earnings are tax free; 40% are taxable

40% x 2800= $1120

You have $1120 of taxable income  

**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. Most people come out better having the scholarship taxable before the 529 earnings. 

[sjudge343]

Box one on the 1098 – T was $6154.11

Box 5 for the scholarship was $3500.

our daughter was the recipient it was her Social Security number on the 1098

we took a withdrawal from her 529 plan for the amount of the scholarship $3500.

I am trying to figure out how to file my return in TurboTax such that the $3500 gross distribution Earnings portion of 1086.67 is not subject to the 10% penalty On 529 with drawls. I am struggling with how to complete this in TurboTax as the return is showing the 10% penalty

[Hal_Al]

You didn't say who's name and SS# the 1099-Q is in.  The 1098-T is always in the student's name. But, it doesn't matter. Her board alone is, most likely, more than the  $3500 distribution.  Room and board are qualified expenses for a 529 distribution, but not for a tuition credit.

So, You can just not report the 1099-Q, at all.  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." 

The TurboTax interview can theoretically handle this, but it's just too complicated.  For example, you must enter the 1099-Q before you enter the 1098-T and expenses. In your case, just delete the 1099-Q. It does not need to be entered.

You don't say whether you will be claiming the tuition credit. 

[sjudge343]

I am sorry I am not being clear. This is very confusing to explain I thought it was straightforward but maybe it’s not from your perspective. We received a bill from the university for $13,774. The university applied a $3500 scholarship against that. We took a distribution from her 529 plan to cover the $10,000 difference. That was a 1099Q with Sydney as the recipient our daughter. Further we took a 529 distribution for 3500 which was the amount of her scholarship. That was a 1099Q in my wife’s name who is the account owner. We took the $3500 distribution because essentially it was excess money and the 529 plan we would not need and we were told that could be withdrawn without paying the 10% penalty. I am struggling as to how to get TurboTax online to  take the $3500 distribution into the form without charging a 10% penalty on the earnings portion.

[Hal_Al]

To get the result you want; first enter the 1099-Q for $3500 distribution ($1087 Earnings). When you enter the 1098-T, on your return, enter $3500 in both Box 1 and Box 5 (you adjust the box 1 amount because the remaining expenses have already been allocated to Sydney's 1099-Q).  Do not enter any other expenses. That tells TTax that scholarship covered the expenses, so the 529 distribution is taxable, but the scholarship penalty exception applies. 

This assumes you are not trying to claim a tuition credit too.  Unless your income is too high, you should be claiming a tuition credit, even if Sydney has to pay some tax on her 529 distribution and/or her scholarship.   The American Opportunity Credit only takes $4000 of tuition to get a $2500 tax credit.

[sjudge343]

TY - our AGI is over 500k so I am assuming we don’t qualify for any credits…

I will try your recommendation.

[Hal_Al]

If you do this again next year, consider making the distribution to the student, instead of you. Even though the "kiddie tax" applies to this type of unearned income, the taxable  amount ($1087) was low enough to go untaxed on her return (depending on her other income).

[sjudge343]

Thank you for the tip.

[sjudge343]

I entered the 1099 Q with my wife as the recipient for the 3500.  The question was tell us the student who‘s education expenses were paid with the distribution reported on the 1099.  I indicated this distribution was not used to pay any education expenses.

on the 1098 T I adjusted box one and box 5 to 3500.  There are no other educational expenses in the return. Unfortunately I’m still getting the same result the system is calculating the 10% penalty on the game. Any other ideas?

[Hal_Al]

You should not say distribution  was not used to pay any education expenses.

Is the student not your dependent? The interview is different in that case. 

[Hal_Al]

If the student is not your dependent, you don't enter the 1098-T at all.

At the 1099-Q interview, you indicate that the "student is someone not listed here" rather than "the  distribution was not used to pay any education expenses".

That will eventually get you to a screen to enter the expenses. Enter $3500 for Tuition and $3500 for Tax free assistance (the scholarship).  That tells TurboTax that scholarship covered the expenses, so the 529 distribution is taxable, but the scholarship penalty exception applies.

[sjudge343]

The student is our dependent. She’s my wife’s daughter

[Hal_Al]

In the 1099-Q interview, when asked who the student is, check Sydney, not "the distribution was not used to pay any education expenses".

[sjudge343]

All set thank you. I think I tried that in the education section and it didn’t work but I went into the wages and income section and did the same thing there and that worked.