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007di
Level 1

Please help with 529 / dependent tax rules

New to usage of 529 funds and could benefit from those who have learned the ropes:

In these circumstances: child will be age 19 at end of 2021, has moved out of parents’ house in February 2021 to live with boyfriend’s family (works and supports herself food- and clothing-wise but does not pay rent), will then move to live on campus as a full-time student in August 2021; therefore, the child will not qualify to be claimed as a dependent on parents' upcoming 2021 1040.

Given this, can the parents still pay for her college with 529 funds established by one of them as account owner and she as beneficiary? They plan on paying qualifying college costs incurred in 2021 out-of-pocket, then get reimbursed from the 529 by 12/31/21 and therefore be the recipients of the resulting 2021 1099-Q’s, which will be reported on their (not her) 2021 tax return (does this sound correct?)

Also, would his girlfriend’s parents be able to claim him as a dependent on their 2021 taxes if he lived there for 6 months rent-free (while he paid for his own food etc)?

4 Best answer

Accepted Solutions
Hal_Al
Level 15

Please help with 529 / dependent tax rules

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 $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.

View solution in original post

Hal_Al
Level 15

Please help with 529 / dependent tax rules

There are two types of dependents, "Qualifying Children"(QC) and standard ("Qualifying Relative" in IRS parlance even though they don't have to actually be related). There is no income limit for a QC but there is an age limit, student status, a relationship test and residence test.

A child of a taxpayer can still be a “Qualifying Child” (QC) dependent, regardless of his/her income, if:

  1. He is under age 19, or under 24 if a full time student for at least 5 months of the year, or is totally & permanently disabled
  2. He did not provide more than 1/2 his own support. Scholarships are excluded from the support calculation
  3. He lived with the parent (including temporary absences such as away at school) for more than half the year
  4. He must be a US citizen or resident of the US, Canada or Mexico
  5. He must not file a joint return with his spouse or be claiming a dependent of his own
  6. He must not be the qualifying child of another taxpayer

 

So, it doesn't matter how much he earned. What matters is how much he spent on support. Money he put into savings does not count as support he spent on him self.

The support value of the home, provided by the parent, is the fair market rental value of the home plus utilities & other expenses divided by the number of occupants.

The IRS has a worksheet that can be used to help with the support calculation. See: http://apps.irs.gov/app/vita/content/globalmedia/teacher/worksheet_for_determining_support_4012.pdf

 

Furthermore, there is a rule that says IF somebody else CAN claim him as a dependent, he is not allowed to claim himself. If he has sufficient income (usually more than $12,400), he can & should still file taxes. In TurboTax, he indicates that somebody else can claim him as a dependent, at the personal information section.  TT will check that box on form 1040.

View solution in original post

Hal_Al
Level 15

Please help with 529 / dependent tax rules

 The treatment of expenses paid with distributions from Sec. 529 plans and Coverdell ESAs in the support test is uncertain because of the dual nature of these college savings vehicles and a lack of IRS guidance. The consensus among tax experts is that it is parental support, because the parent is the owner of the plan.  It would be helpful to make distributions to the owner, not the beneficiary or school, if you are trying to claim her and to the beneficiary or school, if you want her to claim herself. But, neither is a guarantee. 

 

References:

https://www.savingforcollege.com/articles/the-impact-of-529-plans-on-claiming-a-dependent

http://www.aicpa.org/publications/taxadviser/2010/august/pages/nichols_aug-2010.aspx

View solution in original post

Hal_Al
Level 15

Please help with 529 / dependent tax rules

Q. Would his girlfriend’s parents be able to claim him as a dependent on their 2021 taxes if he lived there for 6 months rent-free (while he paid for his own food etc)?

A. No. An unrelated person cannot be a "Qualifying child" and would have to meet the Qualifying relative rules, which would mean (at a minimum) he would have to live with you all year.

 

A person can still be a Qualifying relative dependent, if not a Qualifying Child, if he meets the 6 tests for claiming a dependent:

  1. Closely Related OR live with the taxpayer ALL year
  2. His/her gross taxable income for the year must be less than $4300 (2020).
  3. The taxpayer must have provided more than 1/2 his support

In either case:

  1. He must be a US citizen or resident of the US, Canada or Mexico
  2. He must not file a joint return with his spouse or be claiming a dependent of his own
  3. He must not be the qualifying child of another taxpayer

View solution in original post

5 Replies
Hal_Al
Level 15

Please help with 529 / dependent tax rules

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 $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.

View solution in original post

Hal_Al
Level 15

Please help with 529 / dependent tax rules

There are two types of dependents, "Qualifying Children"(QC) and standard ("Qualifying Relative" in IRS parlance even though they don't have to actually be related). There is no income limit for a QC but there is an age limit, student status, a relationship test and residence test.

A child of a taxpayer can still be a “Qualifying Child” (QC) dependent, regardless of his/her income, if:

  1. He is under age 19, or under 24 if a full time student for at least 5 months of the year, or is totally & permanently disabled
  2. He did not provide more than 1/2 his own support. Scholarships are excluded from the support calculation
  3. He lived with the parent (including temporary absences such as away at school) for more than half the year
  4. He must be a US citizen or resident of the US, Canada or Mexico
  5. He must not file a joint return with his spouse or be claiming a dependent of his own
  6. He must not be the qualifying child of another taxpayer

 

So, it doesn't matter how much he earned. What matters is how much he spent on support. Money he put into savings does not count as support he spent on him self.

The support value of the home, provided by the parent, is the fair market rental value of the home plus utilities & other expenses divided by the number of occupants.

The IRS has a worksheet that can be used to help with the support calculation. See: http://apps.irs.gov/app/vita/content/globalmedia/teacher/worksheet_for_determining_support_4012.pdf

 

Furthermore, there is a rule that says IF somebody else CAN claim him as a dependent, he is not allowed to claim himself. If he has sufficient income (usually more than $12,400), he can & should still file taxes. In TurboTax, he indicates that somebody else can claim him as a dependent, at the personal information section.  TT will check that box on form 1040.

View solution in original post

Hal_Al
Level 15

Please help with 529 / dependent tax rules

 The treatment of expenses paid with distributions from Sec. 529 plans and Coverdell ESAs in the support test is uncertain because of the dual nature of these college savings vehicles and a lack of IRS guidance. The consensus among tax experts is that it is parental support, because the parent is the owner of the plan.  It would be helpful to make distributions to the owner, not the beneficiary or school, if you are trying to claim her and to the beneficiary or school, if you want her to claim herself. But, neither is a guarantee. 

 

References:

https://www.savingforcollege.com/articles/the-impact-of-529-plans-on-claiming-a-dependent

http://www.aicpa.org/publications/taxadviser/2010/august/pages/nichols_aug-2010.aspx

View solution in original post

Hal_Al
Level 15

Please help with 529 / dependent tax rules

Q. Would his girlfriend’s parents be able to claim him as a dependent on their 2021 taxes if he lived there for 6 months rent-free (while he paid for his own food etc)?

A. No. An unrelated person cannot be a "Qualifying child" and would have to meet the Qualifying relative rules, which would mean (at a minimum) he would have to live with you all year.

 

A person can still be a Qualifying relative dependent, if not a Qualifying Child, if he meets the 6 tests for claiming a dependent:

  1. Closely Related OR live with the taxpayer ALL year
  2. His/her gross taxable income for the year must be less than $4300 (2020).
  3. The taxpayer must have provided more than 1/2 his support

In either case:

  1. He must be a US citizen or resident of the US, Canada or Mexico
  2. He must not file a joint return with his spouse or be claiming a dependent of his own
  3. He must not be the qualifying child of another taxpayer

View solution in original post

007di
Level 1

Please help with 529 / dependent tax rules

Thank you very much for your feedback and detailed answers Hal_Al. Greatly appreciate the help in understanding it all, and have printed your answers to keep for next tax filing season. Thanks again.

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