529 1099Q has parent/account owner as recipient and box 6 checked when distribution was used for child/beneficiary

[fredh]

My 1099-Q form shows me, the parent/529 account owner, as the recipient (because I mistakenly had the distribution deposited into my bank account, instead of directly paying my child's private elementary school). I have documentation showing I paid my child's school.  Also, box 6, "If this box is checked, the recipient is not the designated beneficiary", is checked. If I try to enter the form exactly as I received it, into TurboTax the distribution becomes taxable, which is not correct.

In reading this article, it sounds like entering my 1099-Q form into TurboTax is not required. However it also sounds like since box 6 was checked, if I don't enter the form with my tax return, I may enter into an unwanted exchange with the IRS.

Here are some of the key statements from the above linked article:

"If that box is checked, the IRS computers are apt to send out deficiency notices assessing tax, interest, and penalty, even when you know with certainty that the withdrawals were tax-free based on your beneficiary’s qualifying college expenses."

"Some will advocate attaching a statement to your tax return that details your beneficiary’s college expenses and explains that the withdrawals are tax-free, but I am not convinced that will help."

I called the 529 plan administrator, just talking to the first person I could get on their general phone line and it sounded like they may not send me a corrected form, since the form is correct from their perspective, but not mine. Should I push them harder, providing them documentation of the related education expense for the child/beneficiary?

How should I proceed?

Thank you.

[Hal_Al · Accepted solution]

Box 6 is  irrelevant.  You did not make a mistake in having the money sent to you.  It does not matter where the money was sent as long as the student's tuition was paid in the same year as the distribution.  

A corrected form is not warranted. Don't push them. They have done it right. 

Just forget about the 1099-Q. The original advice is correct. 

You can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, to cover the distribution. 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 (you don't need it. All you need is receipts that the tuition was paid)

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." 

Box 6 being checked does not trigger the IRS computers. 

[svdp88a]

I am having trouble with entering turbotax and am not sure I am entitled to the Lifetime Learning Credit. Here is the scenario:

My parents set up a 529 plan for me years ago and I started part-time graduate studies in Fall 2021, but also currently taking Spring 2022 courses (which were paid by the plan in Dec. 2021).  I had the money go directly to the college from the plan.  When the plan issued the 1099Q (to me), they issued it for $8,400, which was the total distribution for the Fall and Spring Semesters ($4,200 x 2); however, the college issued the 1098T (to me) for $4,200 (for only the Fall semester).

It is my understanding that I would not pay any taxes on this distribution.  However, how do it enter it in turbotax  so that I am not having to include income? 

Also, would I be entitled to any Lifetime Learning Credit?

Thanks.  

[Hal_Al]

@svdp88a The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return. 

You claim the tuition credit, or report scholarship income, or claim a 529 distribution as tax free, based on your own financial records, not the 1098-T. In the 1098-T screen, click on the link "What if this is not what I paid the school" underneath box 1. You will then be able to enter the actual amounts paid ($8400 in your case).

That said, you don't need to enter the 1099-Q, at all. 

You can just not report the 1099-Q, at all, if the student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. 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. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. You also cannot count expenses that were paid by tax free scholarships. You cannot double dip! 

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." 

Q.  Would I be entitled to any Lifetime Learning Credit (LLC)?

A. You can't double dip. But, you can decide to claim the LLC, instead of using all the tuition to make the 529 distribution  tax free.  Better yet, if you are a half time or more student, room and board (even if living off campus) are qualified expenses for a 529 distribution, as are books and computers.  You may have enough other expenses, for the 1099-Q,  to use all the tuition for the LLC.

_______________________________________________________________________________________

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. 

[GREEN_S]

Thank you for asking the question as I had exact same situation. Thanks to CHAMP for answering. I will not enter the 1099Q

[bkpickering]

My situation is similar (529 / 1099Q is in my name / SSN as the parent, with box 6 checked).  Note: 1098-T from school is in student's name.  Furthermore, since my dependent daughter is in her final year of college and there is extra $ still in her 529 account, we decided to withdraw additional $ that equaled her scholarship amount.  I hope that this additional $ can somehow be entered on her tax form so that it is taxed at her tax rate.  Since forms are in parent's name, TurboTax has me enter all numbers on my form. Any guidance on how to enter distributions and expenses so that the student pays the tax for the excess distribution amount (at her lower rate)?

Also, i believe that due to our income, we don't qualify for either educational tax credit.  However, can the student quality for either by entering on their tax form?

[MarilynG1]

Yes, your daughter can report Excess Scholarship Income on her return.  

She will indicate she is 'a dependent' on her return and enter her Education documents on her return.

Since she had no 'out of pocket' expenses (all were covered by Scholarships/529 Funds), she won't qualify for a credit.

Here's more info on Qualified Education Expenses and Education Credits. 

@bkpickering 

[Hal_Al]

Q. Can this additional $ somehow be entered on her tax form so that it is taxed at her tax rate?

A. No.  The taxable earnings have to go on your return, because you were the "recipient" of the funds (the 1099-Q is in your name and SS#).

You could have done it, differently. But. it's too late now. You had the choice of having the distribution sent to you, the student or the school.  If either of the latter, she would have been the recipient.  The good news: there will only be a little difference, as most of the taxable earning are subject to the kiddie tax (taxed at the parent's rate, even on the child's return). 

Q.  However, can the student quality for either of the tuition credits, by entering on their tax form?

A. Probably not, since she is your dependent.  

While technically there is a provision that allows your student-dependent to claim a federal tuition credit, from a practical matter it seldom works out.  A student, under age 24, is only eligible for the refundable portion of the American Opportunity Credit (AOTC) if he/she supports himself by working. She cannot be supporting herself on student loans & grants and 529 plans and parental support.  It is usually best if the parent claims that credit.  

If the student actually has a tax liability, there is a provision to allow him/her to claim a non-refundable tuition credit. But then the parent must forgo claiming the student as a dependent, and the $500 other dependent credit.  The student must still indicate that he can be claimed as a dependent, on his return. This is worth up to $2500 (AOTC shifts to all non refundable). Any tuition used by her to claim the credit, reduces the amount you can use to claim the earnings exclusion on the 529 distribution. The AOTC only requires $4000 of tuition to get the maximum credit. The Lifetime Learning Credit (LLC) requires $10K. 

You say this is her last year, on college. There is a 4 time limit to claiming the AOTC (student and/or parents). But, if you're not eligible this year, you probably weren't in the past either.  

[Hal_Al]

@MarilynG1  brings up a good option.

If her scholarship was not restricted to being used for tuition, you have the option of having her declare some of her scholarship as taxable income, rather than you paying tax on the 529 plan earnings.  That is, you shift some of the qualified expenses from the scholarship to the 529 distribution*. 

Why is this a better option? 

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).  It is not earned income for the kiddie tax and other purposes (EIC, IRA contributions).  So, depending on how much other income she had, she can declare up to $12,950  of her scholarship as taxable and still not pay any tax on it. 

*There are three things you can do with your Qualified educational expenses (QEE):

1. Allocate then to scholarships (so that the scholarship remains tax free)
2. Use them to claim an education credit
3. Allocate them to the 529 distribution (1099-Q) so that it will not all be taxable

[Hal_Al]

@bkpickering 

These gimmicks can get a little trick in entering in TurboTax.  Reply back for details, once you decide what to do. 

The IRS actually encourages use of this technique, to claim a tuition credit.  From the form 1040 instructions: “You may be able to increase an education credit if the student chooses to include all or part of a Pell grant or certain other scholarships or fellowships in income. For more information, see Pub. 970, the instructions for Form 1040 and IRS.gov/EdCredit".  PUB 970 even has examples of how to do the “loop hole”.

The same technique can be used to switch expenses to a 529 distribution.