Why is a portion of my 529 plan distribution taxable when all distribution amount was used to pay qualified education expense

[BobLiu]

I was paying college for my child and trying to get distribution from 529 plan to reimburse myself.

On my 1098-T Box1 (total expense) = $53,236, Box5 (school grant)=$24,500, so my out of pocket expense for 2022 is $53,236-$24,500=$28,736

On my 1099-Q, Gross distribution = $20,007 ($9,417 is earning). 

Because distribution $20,007 is less than what I paid $28,736, I think the distribution should be fully deductible, yet TurboTax shows I owe a tax of $598. I looked into the 1099-Q form calculation sheet (page 3), under the “qualified tuition problem computation of taxable distribution” section on line 2b, there is an amount $18,736, but I don't know how the number came to be.

[TeresaM]

Just to confirm, the student is listed as a dependent on your return? And you have entered the Form 1099-Q and the Form 1099-T?  Were there any room and board expenses?

It would be helpful to have a TurboTax ".tax2022" data file for the return that is experiencing this issue. We will then be able to see exactly what you are seeing, so we can determine what exactly is happening in your return and provide you with a resolution. 

Please, also tell us any states included in the return.  

You can send us a “diagnostic” file that has your “numbers” but not your personal information.  If you would like to do this, here are the instructions for TurboTax Online: 

Go to the dark panel on the left side of your program and select Tax Tools. 

1. Then select Tools below Tax Tools. 
2. A window will pop up which says Tools Center.  
3. On this screen, select Share my file with Agent. 
4. You will see a message explaining what the diagnostic copy is.  Click okay through this screen and then you will get a Token number. 
5. Reply to this thread with your Token number. This will allow us to open a copy of your return without seeing any personal information.  

If you are using TurboTax Desktop, these are the instructions: 

1. Go to the top Menu Bar and select Online
2. Select Send tax file to Agent. 
3. You will see a message explaining what the diagnostic copy is.  Click okay through this screen and then you will get a Token number. 
4. Reply to this thread with your Token number. This will allow us to open a copy of your return without seeing any personal information.  
   
   @BobLiu

[Hal_Al]

TurboTax has done it wrong.  The simple fix is to just delete the 1099-Q.

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! 

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." 

There are two Lines 2b of the 1099-Q worksheet. One is for penalty waiver due to the student's disability.  The other is Qualified Elementary and Secondary Education Expenses applied.

[BobLiu]

Hi Hal_AL

Thanks very much for weighing in. I am afraid not reporting 1099-Q would cause trouble from IRS.  on 1099-Q I received, it says: The amount reported below may be taxable to you... I have to prove it is not using numbers.

[Hal_Al]

When (and if) if you ever get TT to do it right and show the numbers, it will enter nothing on the IRS forms. Nothing will be sent to the IRS about your proof.  Your chances of getting an IRS letter are the same, whether you enter it or not. I know this personally. I got a CP2000 from the IRS over my 1099-Q. That's when you provide the proof with numbers. In my case, I just sent them a copy of the school billing statement. I got a letter back saying nothing was owed. 

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.  We have noticed, here in this forum, that the number of 1099-Q notices, from the IRS has dropped off significantly in recent years.

[BobLiu]

Hi Teresa,

Thanks for trying to help. Instead of uploading my data file for diagnosis as you suggested, I called in and did  screen sharing with a support rep. He couldn't figure out why either but suggested that I delete 1099-Q altogether, because clearly in my case the distribution(reimbursement) amount is less than the education expense I paid.  

However, I found the correct answer from another post by Hal_Al, without deleting 1099-Q. Thanks for the suggestion of sending data file anyway, I will keep it in mind in case I run into a harder issue.

[BobLiu · Accepted solution]

The correct answer is provided by Hal_AL in this post below, Kudos to @Hal_Al , who certainly knows the topic to the heart. 

https://ttlc.intuit.com/community/college-education/discussion/why-is-tt-taxing-my-1099q-distributio...

The solution for my case is as follows:

PLAN C.  On the Student Information Worksheet (abbreviated Student Info Wk on the forms list), go to part VI and change line 17 (“Used for credit”) to 4000. Make the change in the first column.  That will automatically change the other columns.

My brief explanation: TurboTax "reserved" $10,000 education credit for you initially, but failed to go back "freeing" it after it figured out you are not qualified to claim such credit after all. To me this is certainly a bug, still haven't fixed it after 1 year.

[Hal_Al]

@BobLiu  TT has finally acknowledged the bug and is working on it.  But I doubt it will be fixed this season.