TurboTax Desktop is not giving me the best education credit

[KWR1]

I am on a Mac with TurboTax Desktop. I am the parent filing our taxes.

My daughter has QEE from    1098-T  box 1   $27008.00

Scholarships                               1098-T box 5   $15750.00

Additional QHEE for the purpose of 

QTP/529 and ESA/Coverdell disbursements.    $6358.48

Disburs. from QTP/529   to me the parent       $17336.00    earnings - $2087    basis $15249

Disburs. from Coverdell/ESA to daughter            $275.28

Turbotax is first applying scholarships toward the QEE as I would expect and getting $11258.00 "left over."

       27008-15750  =11258

Then turbotax applies the 11258 toward the QEE disbursements not covered by the scholarships so that they aren't taxable, but they are also not giving us the Lifetime Learning Credit (LLC). We have already used the American Opportunities Credit (2019, 2020, 2021 and 2022). Expenses for her spring semester of her senior year in 2023 were paid in 2023 so as I understand it, the LLC should be able to be used. 

My understanding is that in order to take the LLC, $10,000 from the QTP/ESA disbursements would now need to be considered income (I was taking it on parents return since the large QTP check was made out to me) to get the credit. Since the QEE as calculated by turbotax and listed above (11258) is greater than $10,000 (needed for LLC) and below the amount of her scholarships, my understanding is that there is no 10% penalty on the disbursement income - only regular tax on the earnings part applied to the $10,000.

I have tried tricking turbotax into giving the credit and no penalty, but nothing I tried worked.

A post from 2021 says 

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   

and that turbotax allocates them in that order, but that does not seem to be the case now - the last two seem to be switched. 

How can I get turbotax to consider $10,000 of the QTP disbursement to be income, give us the education credit and not take the 10% tax penalty? Or where am I misunderstanding what is going on?

[Hal_Al]

Q. How can I get TurboTax (TT) to consider $10,000 of the QTP disbursement to be income, give us the education credit and not take the 10% tax penalty? 

A. That should happen automatically.  Enter the 1099-Q before you enter the 1098-T and other expenses. 

Go back to the education expenses and scholarships section. At the screen titled "Your Education Expenses Summary".  Click edit next to the student's name. That should take you to a screen “Here’s your Education Summary”. Click edit next to “Education Information”. You should reach a screen titled “Amount Used to Calculate Education Deduction or Credit”, verify the amount ($10,000) you want to use or change it.  If you never get that screen, or still don't get the expected result, reply back and I'll give you a workaround. 

You say $6358.48 additional QHEE for the purpose of  QTP/529 and ESA/Coverdell disbursements. You didn't specifically mention room &board (R&B). While R&B are not QHEE for the tuition credit or tax free scholarship, R&B is QHEE for a 529/ESA distribution.  

Making some of the student's scholarship taxable is usually a better alternative to making the 529 distribution taxable, depending on how much other income the student has and/or whether the scholarship is restricted to paying tuition. 

The full $10,000 of the disbursement does not become taxable, only a portion of the earnings. 

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)

[KWR1]

I didn't specify room and board but that is what the QHEE of 6353.48 is. I do understand that room and board are only QHEE for the disbursements and not for the credit. I also understand that it is only the earnings portion of the disbursements that are taxable.

I removed the 1098-T form and other expenses as well as the 1099-Q forms. I reentered them entering the 1099-Q first and then the 1098-T form. I  never got a screen that said "Amount Used to Calculate Education Deduction or Credit".  From the "Here's Your Education Summary" I clicked the Edit button beside "Education Information." This took me to the following pages (some titles are abbreviated and name removed).

    "Was she Working on an....Degree?"   - answer yes

    "What Was her Enrollment Status for 2023?   - answer full-time

    "Had she Earned 4 Years of College Credit Before 2023?"  answer no

    "Is this her First Year of College?"  answer no

    "Did she Ever Receive the American Opportunity...?" answer yes with 4 yrs of AOC claimed

    "This is just one of those things..." answer no

And then back to the "Here's Your Education Summary" page

So as stated above, never got the "Amount Used to Calculate Education Deduction or Credit" page.

After the "Here's Your Education Summary" page, it goes back to "Your Education Expenses Summary." The next page is "Next, We'll See Which Credit Will Save You the Most"

It makes all the choices and doesn't ask for input. It claims to have maximized the savings.

So if there is a workaround, that looks like what I need. Thanks.

[Hal_Al]

Provide the following info for more specific help (I realize you've already provided most of it, but it's easier if it's all in one place):

• 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 both 1099-Qs
• Box 2 of both 1099-Qs
• 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 which 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?

[KWR1]

Here are the answers -

• Are you the student or parent.    Parent
• Is the  student  the parent's dependent.   Yes
• Box 1 of the 1098-T    27008
• box 5 of the 1098-T    15750
• Any other scholarships not shown in box 5   No
• 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       No
• Box 1 of both 1099-Qs            ESA 275.28      529  17336.20
• Box 2 of both 1099-Qs             ESA  0              529 2087.47
• Who’s name and SS# are on the 1099-Q, ... (who’s the “recipient”)?   ESA - student  ; 529-parent
• 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. R&B 6353.48  COA  6525  
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers   None
• How much taxable income does the student have, from what sources  Wages  580 Unearned 1500 so I haven't thought this all the way through, but putting scholarship on her return seems like it will result in more taxes than 529 plan earnings on our taxes.
• Are you trying to claim which tuition credit (are you eligible)? Not eligible for AOC. Since we paid the spring semester in 2023, we are eligible for LLC. Trying to claim LLC
• Is the student an undergrad or grad student? undergrad
• Is the student a degree candidate attending school half time or more?  yes

Parents taxable income is between 160,000 and 180,000 so we know that we can not get the full credit.

[Hal_Al · Accepted solution]

The good news is none of the 1099-Q needs to be taxable to get the LLC, if the student declares enough of the scholarship as taxable. Technically none of the scholarship gets taxed because of the student's standard deduction*. But the unearned income gets taxed more (about $27 more tax vs. about $265 on your return for the 1099-Q).*** 

This is how you enter, in TurboTax (a workaround):

1. Don't enter either of the 1099-Qs. They're not taxable**.
2. On the student's return, enter the 1098-T with box 1 blank and $10,000 in box 5 
3. On the parent's return, enter the 1098-T with $10,000 in box 1 and box 5 blank. 

The math (You should check my math , I only did it once):

6353 - 275 (allocated to ESA) = $6078 R&B 

27,008 -15,750 = 11,258

11,258 + 6078 = $17,336 Total QEE (which is exactly the amount of the 529 1099-Q)

So, we make $10,000 of the scholarship taxable, so we can claim $10,000 tuition for the LLC. 

*Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $13,850 filing requirement and the dependent standard deduction calculation (earned income + $400, up to $13,850).  It is not earned income for the kiddie tax and other purposes (e.g. EIC).  She needs to file a tax return because the unearned income is more than $1250. Declaring the scholarship taxable actually increases the tax on the unearned income.***

**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. 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”.

***Estimated tax on student's return:

(1500 + 580) – 1250 (standard deduction) = $830 x 10% = $83 Before scholarship is taxable

(10,000 +580 + 1500) – (10,580 + 400) (standard deduction) = $1100 x 10% = $110 After 

$110 - 83 = $27 More tax

Estimated tax on Parent's return:

10,000 / 17,336 = 57% x 2087 = 1204 x 22% =265 

[KWR1]

Thanks so much. I am generally following what you are doing, but it will take me a little time to try it out.

[KWR1]

Thanks again. Yes this works.