why are we being told to pay taxes on the earnings of a Qualified Tution Program?

[joyp]

My husband just completed tax returns both our kids.  Neither had income.  Both received a 1099Q with info for Gross Distribution, Earnings and Basis.  My husband entered all this in turbo tax and both returns ended up with owing taxes on the earnings even though all distributions were for Qualified Educational Expenses.  Other than a couple of Chromebooks and textbooks, all funds were sent directly to their school.  Receipts for the Chromebooks and textbooks were submitted and apparently deemed to be qualified educational expenses as my husband was reimburses.

My husband said he followed all the prompts as far as entering info for the 1099Q, but there was no prompt to enter the amount of Qualified Educational Expenses.  I am thinking that this info is somehow missing and that is why tax is due.  Any help on this would be appreciated.

Thanks!

[KrisD15 · Accepted solution]

After entering Form 1099-Q, continue in the

Deductions & Credits 

Education 

Section

Go to 

"Expenses and Scholarships (Form 1098-T)" and enter the 1098-T from the schools. 

If you don't have that Form, have the students get a copy from their online school accounts. 

[joyp]

This worked initially and tax amount went to zero, but then my husband got a message that the 2 amounts (1099Q and 1098-T) didn't match and he can't go further.

Other than tution (which is on the 1098-T), we submitted a receipt to be reimbursed for a text book that wasn't purchased from the school (so not on the 1098-T).  Not sure how to show that expense, but it IS a Qualfied Educational Expense since a text book was required by the course.

We also submitted a receipt for a Chromebook.  A computer is required for students, but I cannot find that statement on the school's website yet.  When I do, how do I show this?   

Any help that can be provided is most appreciated.  Twins in college--we need all the help we can get!

[AmyC]

1. Enter expenses: from the education summary - edit the areas that need correction.

2. If the 1099-Q was completely used on 529 qualified Room and Board  and Qualified Education Expenses - Internal Revenue Service then the Q does not need to be entered.   IRS Publication 970, Tax Benefits for Education states:

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

3. If you have additional expenses for tuition and fees, you may be able to claim the education credit.  If you qualify for an education credit, that is the first goal. You cannot claim the credit if your MAGI is over $90,000 ($180,000 for joint filers). 

I don't know if there are scholarships in box 5 so I will answer as if there are.

Step 1 -Do you qualify for an education credit (see What You Need to Know about AOTC and LLC

Yes, can claim the credit:

Are the scholarships restricted to paying for tuition?

• If restricted, remove those funds from the eligible scholarships.
• If not restricted, excellent.

How much tuition is in box 1 - we need $4k for AOTC or $10k for LLC

• For AOTC
• If less than $4,000 we want to use it all and make the scholarships go 100% toward room and board.
• If more than $4,000, scholarships can cover the amount over $4,000 and the rest to room and board.

No, can't claim the credit:

• the 1098-T is not entered on the parent's return and might need to be entered on the student return. if the scholarship exceeds tuition.

Does the student need to file a tax return is the next question. Take this quick quiz, Filing requirement. 

[joyp]

Thanks so much!  I will read all this VERY carefully in the AM (I am whipped!)

My husband thinks he has figured out the issue.  The amounts on the 1099Q don't match the 1098-T due to a timing issue.  The 1099-Q recorded the amounts on the date we requested it.  The 1098-T seems to be from when the college posted the payment.  It takes some time for the 529 plan to issue a check (they don't do electronic) and then the college is closed for winter break.  So the amounts fall in different years.  

[Hal_Al]

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 regardless of whose money was used to pay 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. A student, with no other income, can have up to $14,600 of taxable scholarship (in 2024) and still pay no income tax. 

[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?