529 earnings taxable?

[mb130]

Hello

I received a payment/withdrawal from my 529 to pay for my son's college tuition and room/board. The 1099-Q shows a basis and earnings. When in Turbo Tax I seem to be taxed on the earnings from the 529(?) But those should be tax-free as long as they are used for qualified expenses.  When I put in the tuition expenses, it appears to deduct from the tax owed, but not when I enter the room/board expenses. What am I missing? I shouldnt be taxed on any of the 529 payments as long as I use them for qualified expenses (which his tuition and room/board is).

Thanks

[Hal_Al]

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. 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! 

References:

1. 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." 2.
2. IRS Pub 970 states: “Generally, distributions are tax free if they aren't more than the beneficiary's AQEE for the year. Don't report tax-free distributions (including qualifying rollovers) on your tax return”.

It sounds like TurboTax (TT) is allocating some of the tuition to the Education Credit, reducing the amount that is allocated to the 529 distribution.  If you are eligible for the education credit, you want TT to do that. See explanation and example below. If you are not eligible, the simple fix is to just delete the 1099-Q and not enter the 1098-T.

The 1099-Q and the  1098-T are only informational documents. The numbers on them are not required to be entered onto your (or your student's) tax return. However receipt of a 1098-T frequently means you are either eligible for a tuition credit or possibly your student has taxable scholarship income. 

_____________________________________________________________________________________________

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 American Opportunity Credit (AOC or AOTC) is 100% of the first $2000 of tuition and 25% of the next $2000 ($2500 maximum credit). 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 which is only qualified for the 1099-Q)

   -$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]

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 on campus charge. If he lives at home, the school’s R&B “allowance for cost of attendance” for student living with parents.
• 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?
• Is the student a degree candidate attending school half time or more?

See example at:

https://ttlc.intuit.com/community/tax-credits-deductions/discussion/529-and-education-credits/00/297...

[Court573]

I am having the same issue.  It's counting 529 as taxable even though all the tuition info is entered.  This is a TurboTax problem in my opinion.  Why is this happening?? 

[DawnC]

If you know that the distributions from the 529 plan are not taxable because they were used on qualified expenses, do not enter the 1099-Q forms.  For most qualified education program beneficiaries, the amounts reported on the 1099-Q aren’t reported on a tax return. 

However, if annual distributions exceed your adjusted qualified education expenses, you may need to report some of the earnings reported in box 2 as income on your tax return and pay an additional 10 percent tax on it as well.    Your adjusted expenses are equal to the total of your qualified education expenses minus other tax-free assistance you receive, such as scholarships and Pell grants. 

For example, suppose your qualified education expenses are $10,000, you receive a $2,000 Pell grant and boxes 1 and 2 of your 1099-Q report a gross distribution of $8,000 and earnings of $1,000. Your adjusted expenses are $8,000—which means you don’t have to report any education program distributions on your tax return.    @Court573 

[Hal_Al]

Q. It's counting 529 as taxable even though all the tuition info is entered.  This is a TurboTax problem in my opinion.  Why is this happening?

A. 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

TurboTax allocates QEE, in that order, until you tell it otherwise. TurboTax allocates QEE, in that order, but it doesn't do a very good job.  It's best if you have some idea of the outcome expected, when you make your entries. 

[Court573]

Our 529 withdrawals were less than our qualified expenses, so definitely no tax owed.  But I don't understand how the government knows this if we don't enter all this information.  We were always told to keep every single receipt, record, etc. of what we paid for college so we don't get hit with any unqualified expenses and now it sounds like we don't even need to report that info to anyone?  Seems strange to me.  We don't qualify for the education credit or any type of credit since our income is too high, so I guess we just won't enter any info.  Thanks! 

[Hal_Al]

Q. We were always told to keep every single receipt, record, etc. of what we paid for college so we don't get hit with any unqualified expenses and now it sounds like we don't even need to report that info to anyone?

A. That can be a problem.  As previously noted; 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. 

In the past, we saw several posts, in this forum, about IRS notices about the 1099-Q. I got one personally.  So, hang on to those receipts. 

 At least two users have reported receiving a CP2000 letter, from the IRS, on 529 distributions. They replied that their child was in college and the distributions were for qualified expenses, which they listed, but they did not provide receipts.. They  later received a notices saying they were in the clear. Others have reported that just sending copies of school statements satisfied the IRS. We have noticed, here in this forum, that the number of 1099-Q notices, from the IRS has dropped off significantly in recent years

[douginsd]

I'm having the same issue as Court573. 

I entered the distribution amount, the tuition paid, and room/board paid in the appropriate boxes.  For some reason Turbo Tax doesn't deduct the full amount of expenses in the worksheet and figures out taxes owed on the balance that wasn't used.  When I right click on the balance in the worksheet there's no clue as to how that value was calculated, so I can't figure out where its going wrong.  Its off by exactly $9,000, which has nothing to do with any of my entries, so its not like it just missed something obvious like one of the expenses.  I can right click on it and override it to the correct value, and then the tax owned goes back to 0, which is what I've done for now to fix the problem.

Since my distribution is exactly the same as the tuition plus room/board, I could just go back into the interview and say no to the 529 distribution question and avoid the entire problem.  Is there any advantage to having the worksheet in my records along with the override value I had to provide to correct the mistake Turbo Tax appears to be making?

edit:  I just went back in to take another look at this topic, and realized there was one step that I hadn't completed.  In the college expense interview section, there are a few sections to complete.  Some have dollar values displayed next to them, but the last one at the bottom called "Education information" doesn't have any dollar amount next to it.  I had completed all the sections with dollar values, so I thought the tax calculations were complete at that point, but apparently they were not.  In "Education information" there are several questions that need to be answered to verify the student is meeting all of the requirements for using the 529 distribution.  After answering those questions, my tax calculation finished correctly without needing the override value.

[Hal_Al]

Q. Is there any advantage to having the worksheet in my records along with the override value I had to provide to correct the mistake Turbo Tax appears to be making?

A. Simple answer: No.  Theoretically, it's a document you could just give to the IRS, in case of an inquiry, but that's unlikely to be enough to satisfy them. 

There are two things you didn't mention, in your post: 1. Are you eligible to claim the tuition credit (primarily is your income not too high). 2. Did the student have any scholataships.  The usual reason for TT making the 529 partially taxable is that expenses have been allocated away from the 1099-Q and allocated to the tuition credit and/or scholarship.

[Lost_in_Austin]

I also had the same issues as Court573, Douginsd, and others. It was driving me insane. I was about to take the advice here of just deleting the 1099Q and 1099T since I know that we didn't take out as much as we spent, but then I saw the edit to Douginsd's post, went back in and edited that section, and color me stunned, it worked. 

I will say, though, I think Turbo Tax needs to revise this section and make it more clear and obvious. You aren't prompted to answer those questions and that section does not look like it is as crucial as it clearly is.

Thanks to all on this thread for your help.

[mmatrull]

I had filled out the Education Information section previously and returned and did it again but it made no impact on the Qualified Expenses adjustment that TT seems to be making.  Do you know what question impacted yours?  They all seem like very straightforward questions to me...I can't think of anything I'm answering there that would limit my Qualified expenses.

[AmyC]

Under books is the room and board question. If you have not subtracted those extra expenses, that would confuse things. If you have no taxable income from the 529, the IRS does not want it reported.

IRS Publication 970, Tax Benefits for Education states:

If the entire 1099-Q went to qualified expenses, room and board, tuition, etc then you do not need to enter the form. Tuition paid for the first 3 months of the next year also qualify, see page 12, What Expenses Qualify, and page 52 for qualified distributions.

Page 45  repeats: Don't report tax-free distributions (including qualifying rollovers) on your tax return.

@mmatrull