529 Withdrawal vs Taxable Scholarship

[CMS7]

My daughter received scholarships in 2020 and we also withdrew money from my daughter's 529.  I have two related questions:

- Although the scholarships can be considered non-taxable, is it allowed for our daughter to enter them as taxable on her return and pay taxes on that amount, and have us therefore reduce the amount of nontaxable scholarship income by the same amount?  This would reduce the overall amount of taxes we would have to pay on the 529 earned income.   Would we do this by going to the Student Info Worksheet and entering it into Part V, Item 4 (amount required to be used for other than qualified education expenses)? 

- Some of her scholarships are required to be used for tuition, while one is allowed to be used for anything.  Does that make a difference (i.e., would we only be allowed to do this on the one scholarship that can be used for anything)?

[Anonymous]

How much did you pay for tuition?

How much did you take out of your 529?

How much was the scholarship (what did she spend it on)?

Did you get a 1098-T? What numbers were in the boxes?

[CMS7]

Tuition and fees totaled $51,612; books and other expenses $191; room and board $9412

We took out $50,164

Scholarships included $25,000 with no restrictions and $11,050 restricted to tuition/etc.  There was also employer-provided assistance.  Per the rules, $5250 of that was considered nontaxable and the rest was already included in her W-2. 

All the scholarships went directly to the school, so it was spent to fully cover the tuition and costs, including room and board.  She actually got some money back from the unrestricted scholarship.

We did not receive a 1098-T from the school.  Apparently the rules say that the school is not required to submit a 1098-T if the full cost of attendance is covered (which seems weird to me, but I looked it up).

Thanks! 

[KrisD15]

Yes, that makes a difference.

The IRS does allow Taxpayers to allocate expenses to receive the best tax break, but restricted scholarships must be used for what they were intended. In your case towards tuition. 

51803 (51612 + 191) expense less 16300 (11050 + 5250)leaves 35503 tuition/fees expense.

50164 Distribution less remaining tuition leaves 14,661 less room and board (9412) leaves 5,249 for you to claim. In your situation, there seems to be no wiggle room for the student to claim any additional scholarships. 

Are you including all additional costs? Did the student need to purchase a laptop? Did you include meal expense? 

[CMS7]

KrisD15,

Thanks for your reply.  It took me a while to find time to go through your answer in detail, but I think I understand it now.  A couple questions:

- Based on your answer, it appears that, although I have to allocate the restricted scholarships to tuition, I am able to allocate the $25,000 unrestricted scholarship to other expenses in order to get a better tax break.  Am I correct that if I DON'T count the $25,000 as tax-free scholarship funding on my claim, I DO have to have my daughter count the $25,000 as taxable income on her claim?  That's still a good deal, but I want to make sure.

- To answer your question, I did include meal costs, but only for the period when she was at school.  I did not include any cost for meals or other expenses while she was attending class remotely while living at home because school was closed for COVID.  Is it permissible to include some costs while she was at home?

Thanks again!

[CMS7]

KrisD15,

Also, is there a "correct" way to enter the $25,000 scholarship?  I am thinking the correct way would be to:

1 - Go to Forms, and then go to the Student Info Worksheet for my daughter, then go to "Part V: Education Assistance"

2 - In Section V, enter $36,050 in Line 2b (other scholarships, fellowships, and grants), then enter $25,000 in Line 2c (amount required to be used for other than qualified expenses)

This makes the numbers right, although the wording doesn't seem to match exactly.  I think I need to do that on my daughter's return also, though, in order for the $25,000 to be entered as taxable income on 1040 Line 1.

Thanks.

[Hal_Al]

Q. Am I correct that if I DON'T count the $25,000 as tax-free scholarship funding on my claim, I DO have to have my daughter count the $25,000 as taxable income on her claim?
A. Yes. But you can do some of each.
Q. Is it permissible to include some food costs while she was at home, for the 529 distribution?
A. Yes. You can use the lower of your actual costs or the school's meal allowance.
Q. Is there a "correct" way to enter the $25,000 scholarship as taxable?
A. No, but there is a usual way. You will be asked how much of the scholarship was used for room and board. Enter there the amount you want to be taxable. That won't prevent you from saying the 529 distribution paid for R&B. It's just an entry technique (you'll see the results on the work sheet. It puts  it on Line 2c (amount required to be used for other than qualified expenses).  If you use desktop (not online) TT, there's another way to enter it. 

[Hal_Al]

I see no mention of trying to claim the American Opportunity Credit (AOC). I assume you're not eligible because of the income limit.

If you are eligible, you can claim it, by shifting $4000 (or maybe just $2000) of your expenses to it.  You'll have to pay tax on more of the scholarship and/or 529 distribution.  But, the AOC is 100% of the first $2000 and 25% of the next $2000. 

[CMS7]

Thanks.  You are correct, we were not eligible for the credit.

[CMS7]

Thank you.  This is helpful.