1099-Q, 1098-T and related tax reporting question

[BK2000]

Background: Using desktop installed TT Deluxe on Windows. Married filling jointly. Our "Dependent" daughter is a full-time first year college student and she must file her own 2022 taxes due to $5k of reported W2 income. We setup CA Scholarshare 529 for her as the beneficiary and withdrew funds to pay for last fall's expenses, distributed directly to her bank account. She has also received various scholarships. 1099-Q and 1098-T are both issued to her name.

My tax return: I entered her 1099-Q first in my tax return and then the 1098-T, including additional expenses such as room and board etc. The program informs me of the following verbiage:

"Looks like your 1099-Q is taxable. Based on the educational expenses you've entered, the student beneficiary must report $1K of taxable income from this distribution."

It appears that I perhaps miscalculated and withdrew a bit too much from the 529 plan.

Question-1: Where in TT and how do we enter this in my daughter's tax return? Do I remove the 1099-Q data from mine and renter it in hers, including other expenses? Doing so using the [exempt] approach appears that I almost recreate the 1098-T in her return which I doubt is the correct approach. I'd appreciate your detailed guidance. Or is there an alternative entry to report this $1K of taxable income?

Question-2: The amount of scholarship reported on the 1098-T is about $1,500 less than the actual that was applied toward her fall quarter. I contacted the school and they were not helpful - let's just leave it at that. How do I handle this? At this point I don't care about the small taxable loss, I just don't want to deal with getting flagged, especially not her return.
TIA.

[Hal_Al]

Q.2. After entering the 1098-T, you will be asked if there was any scholarship not shown on the 1098-T. You can enter the $1500 there (if you're sure the school is wrong). This is not flaggable issue. 

Q.1. As you now know, this is complicated.  To make it worse, TurboTax does not always do a good job.  That $1000 may or may not be right.  There are several ways to enter it. Some easier than others.

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 1099-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.
• 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 (on the recipient’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

There is  $1120 of taxable income (on the recipient’s return)

**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. 

[Hal_Al]

Q. Do I remove the 1099-Q data from mine and renter it in hers, including other expenses?

A. You do not need to remove the 1099-Q, from your return.  Because you identified the student as the recipient, TT does not enter anything about the 1099-Q on your return. It calculates the taxable amount and advises you to enter it on the student's return.  This will provide you a double check when you do enter it on her return.

Q. Do I enter the 1099-Q  in hers, including other expenses?

A. Yes. Since she is the recipient, any taxable amount gets reported on her return. 

Q. Doing so appears that I must recreate the 1098-T in her return which I doubt is the correct approach.

A. It is OK to enter the 1098-T on both returns. On your return, to claim the tuition credit and on her return to calculate and report the taxable portion (if any) of the 1099-Q.  In her interview, you should reach a screen  titled “Amount Used to Calculate Education Deduction or Credit”, verify the amount you  used, on your return (usually $4000), or change it.  If you are not eligible for the credit, the amount should be 0. 

The calculations are complicated and TT doesn't  always get it right. It pays to have an idea of what the output will be. See example in my other reply.  For more specific help, provide the info listed in my other reply.

[BK2000]

Hello @Hal_Al  and Thank you for your time.  Here are the answers to your bulleted questions and looking forward to more specific guidance - THANK YOU.

• Are you the student or parent? I am the parent
• Is the student the parent's dependent? Yes
• Box 1 of the 1098-T: $3,404
• box 5 of the 1098-T: $2,250
• Any other scholarships not shown in box 5? Yes, $1,584 (I don't know why they are not showing it in 1098-T because all scholarships and state grants came from the school and applied to the student's account, and not from other outside sources)
• Does box 5 include any of the 529/ESA plan payments (it should not)? No
• Is any of the Scholarship restricted; i.e. it must be used for tuition? Not that I am aware of
  
• Box 1 of the 1099-Q: $13,300
• Box 2 of the 1099-Q: $ 5,472
• Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)? Student
• Room & board paid. If student lives off campus, what is school's R&B charge: Lives ON campus, $7,262
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers: $6,139
• How much taxable income does the student have, from what sources: $5,961 from W2
• Are you trying to claim the tuition credit (are you eligible)? Yes and Yes, looks like I get $1000 AOTC.
• Is the student an undergrad or grad student? Undergrad

When I try entering education expenses in student's tax return, TT warns that she is considered a dependent on someone else's return (mine).  I think this is the double-dipping warning?

On the scholarship reporting discrepancy (the $1,584), TT asks "Was any of the scholarship income not designated to pay 2022 education expenses?"  This scholarship amount showed up on her student account in December.  So it is possible it was meant for 2023, however since her account was fully paid, they sent me a refund, so technically they were all applied in 2022 (UNLESS, unless they applied it to the Jan 2023 Room & Board payment that I had to pay in Dec 2022).  So I don't know if I should answer No to the question (leading to increased student taxable income of $1,782), or answer Yes and enter the $1,584 scholarship which reduces the student's taxable income to $1,130.  I am concerned about the ramification of answering yes because I don't know what it does for the 2023 tax year.

[Hal_Al · Accepted solution]

As to the $1584 scholarship, you decide which year it goes against.  Just be consistent . If you treat as 2022 on your 2022 return, don't treat it as 2023 on your 2023 return. I would call it 2022, based on your description. This is a common problem, we see in this forum.

Based on the results, it appears you you have successfully enter things in TT (I get $1782 also*).   There should be no penalty (having scholarship and using the AOC are penalty exceptions). Verify that on form 5329. 

There is an alternative: have her claim the $3834 of scholarship as taxable income**.  That reduces the $1782 to about $204. Saves about $140 in tax.  It may get a little tricky entering in TT, but  I think I can walk you through it. 

*3404 + 7262 + 6139 = 16805 QEE (qualified educational expenses)

16805 - 4000 (used for AOC) -3834 Scholarship = 8971 QEE available for 1099-Q

8971 / 13300 = 67.45% tax free

0.3255 x 5472 = $1782 taxable portion of the distribution

** So, how can reporting $3834 of income be better than reporting $1782 of income? Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $12,950 filing requirement and the dependent standard deduction calculation (earned income + $400).  The $1782 is unearned income.  So, even though it's reported as income, it doesn't get taxed. It is not earned income for the kiddie tax and  IRA contributions.

[Hal_Al]

A student-dependent must file a tax return for 2022 if he had any of the following:

1.          Total income (wages, salaries, taxable scholarship etc.) of more than $12,950 (2022).
2.          Unearned income (interest, dividends, capital gains, unemployment, taxable portion of 529 distribution) of more than $1150 (2022)
3.          Unearned income over $400 (2022) and gross income of more than $1150 (2022)
4.          Household employee income (e.g. baby sitting, lawn mowing) over $2300 ($12,950 if under age 18)
5.          Other self employment income over $432, including money on a form 1099-NEC

If she declares the $3834 of scholarship as income, the taxable portion of the 1099-Q is reduced to $204.* That's less than $400 (#3 above). Technically, she does not need to file a tax return, unless she needs to get a refund of withholding from her W-2.  The $204 is covered by the extra $400 standard deduction (earned income + $400), so there is no tax. 

You may want to file just to document the reporting of the income.  

*$16805 QEE - 4000 (used for AOC) = $12,805 available for 1099-Q.

12805 / 13300 = 96.28% of earnings are tax free

0.0372 x 5472 = $204 taxable income

[BK2000]

Hello @Hal_Al 

You wrote: "There is an alternative: have her claim the $3834 of scholarship as taxable income**. That reduces the $1782 to about $204. Saves about $140 in tax. It may get a little tricky entering in TT, but I think I can walk you through it."

I need your help please to accomplish this as everything I tried increased the student's tax liability.

In student's tax return: Before, with her existing taxable income of $1782, she owed $96 in Federal taxes.  Then I added "other income" of $3834 and accordingly responded that I have already reported her scholarships in the income section (to zero it out) and now she owes $320 in Federal taxes!  So clearly I am not doing this right.

TIA for any help you can provide.

UPDATE: I think I figured it out.  I will create a new reply once I am confident, for you to review please.  Thanks.

[Hal_Al]

You have to get the scholarship income ($3834) on line 8r of Schedule 1 rather than line 8z as "other income".  "Other income" is unearned income for the standard deduction calculation, while scholarship income is earned income. 

[BK2000]

@Hal_Al, Still there is one error ...

I am getting much closer as I can reduce the student's taxable income from $1782 to $204 as you mentioned.  I accomplished via entering the total scholarship of $3834 in Wages & Income > Less Common Income > Taxable Scholarships and Fellowships.

But line 8r of Schedule 1 is zero!! and 8z is $204, hence the error below.  The question is, how else should I enter the $3834 so that it does not conflict with the 1098-T's $2250 reported scholarship, plus the unreported $1584

[BK2000]

@Hal_Al 

I found the issue: Adding the actual 1098-T to the student's tax return would

(a) overwrite the field on schedule-1 line 8r and

(b) it would not allow me to reenter or correct the scholarship data - essentially locked the zero value on schedule-1 line 8r (a bug in the program!)

This is how I resolved this:

• I grabbed an earlier version of her return to start fresh
• Entered the total scholarship of $3834 as income (which populated schedule-1 8r with the same $)
• Entered the 1099-Q data
• Entered the school expenses without the 1098-T:  I selected that "I have not received 1099-T" and then selected that "I qualify for an exception".  Hence I didn't have to enter any scholarship data - no duplicates.
• TT clearly identifies that she cannot get the education tax credit (since I will be getting it)

Now the her additional taxable income is reduced from $1782 to $204.  Her end result is a Fed tax refund of $43.

Q1: Have I correctly done this portion of her tax return as far as you can tell?

Q2 on my tax return: I should enter the 1098-T data but not the 1099-Q (since 1099-Q was fully utilized under the student's return) - do you agree?  This will give me an AOC credit of $1000.  Anything else?

TIA

[Hal_Al]

Q1: Have I correctly done this portion of her tax return as far as you can tell?

A1. Yes and congratulations. As you now know, it's not easy. 

Q2 on my tax return: I should enter the 1098-T data but not the 1099-Q (since 1099-Q was fully utilized under the student's return) - do you agree? 

A2. Yes.

Q3. This will give me an AOC credit of $1000.  Anything else?

A3.  Check form 5329 (and line 23 of form 1040)  to be sure she was not accessed the 10% penalty on the $204.

The AOC comes in two pieces. The refundable portion is on line 29 of form 1040 ($1000 max).  The non-refundable portion is included on line 20 (via Schedule 3) and is $1500 max.  You will not get any of the non-refundable portion, if your tax liability is already 0 (line 16).

[BK2000]

@Hal_Al 

Everything is in agreement with all your suggestions.  I believe I have successfully accomplished this portion. There is NO WAY I could've done this on my own without your help - you are a gem and an MVP.  Not only you educated me but saved us $.  I wish there was a way to repay you.  Regardless, I will promise to pay it forward and encourage others to do the same.

I am sure there will be other questions in the next four years and I look forward to our interaction.

THANK YOU - THANK YOU

P.S. I have a hypothetical question on the use of 529 funds which I created a new post.