Scholarship and AOTC question

[3kidsincollege]

Situation:

Student is my son and filing as an independent taxpayer.

Junior in college, under 4 year ROTC scholarship and receiving State lottery scholarship.

I have a 529 w student as beneficiary.  ROTC scholarship goes to tuition, State lottery scholarship goes to offset some R&B.  Due to scholarships, I am distributing nonqualified funds out each year to student and taking advantage of no penalty distribution.

Some expenses were paid from 529 to me (parent).  These show up on my 1099Q.  I will ignore that for my return as all the expenses are qualified.

1099Q under student's SS#

Box1 25,000

Box 2 12,074

1098T

Box 1 15,230

Box 5 26,730

Box 7 checked

$5,750 of Box 5 was for 2019 costs

Below is how I have approached things.  

Educational expense and application via Scholarship, 529
Tuition and fees $15,230.00
Housing $8,374.00
Meals $4,061.00
Books, etc, ROTC school $1,250.00
Total $28,915.00

Scholarships received and used for 2020 $26,730.00

Expenses not covered by scholarships $2,185.00
Expenses classified as taxable income on Student's return $10,028.00
Expenses used for AOTC $(4,000.00)
Expenses to be used against 1099-Q $8,213.00
Parent's QEP distributions $(4,902.90).  Filed on parent's taxes, 100% qualified expenses.
Student's costs not covered by scholarships $3,310.10

My questions

Looking for input on any areas I am not doing correctly.

When I go thru the TT interview do I enter in all expenses even if paid for via scholarships under "Did you pay for Books or Materials to attend school?"  Books, room and board, etc.  I am confused on this and so far have only put in the amount that falls outside of what I have said is taxable, which is $3,310.

Under "Did you pay for Room and Board with a scholarship", I have put "yes" and inserted $10,028.  I am using this number to maximize the credit.

Under credits, the student received AOTC last year.  For this year, I have put in $4,000 as amount to be used to calculate credit.  

Student's 1040 ends up with 

Wages $13,080 ($3,052 of this is from a job, $10,028 from scholarship)

Line 8 "other income" $10,341, from Qual State Tuition program 1099Q.  It is confusing to me how it comes up with this exact amount.

[Hal_Al]

“Some expenses were paid from 529 to me (parent).  These show up on my 1099-Q.  I will ignore that for my return as all the expenses are qualified”

Yes, you can do that if you know all the expenses are qualified AND your son is not using any of the same expenses on his return.

TurboTax is capable of calculating the taxable amount of the 1099-Q and it sounds like you are on the right track. Yes, enter in all expenses even if paid for by scholarships under "Did you pay for Books or Materials to attend school", books, room and board, etc. Do not include expenses you already allocated to your own 1099-Q.

Yes, Under "Did you pay for Room and Board with a scholarship", put "yes" and insert the number to maximize the credit.

When you reach a screen called "Amount used to calculate education deduction or credit" Be sure the amount in that box is $4000. That will reduce the expenses used for the 1099-Q.

The statements “$5,750 of Box 5 was for 2019 costs” and “Scholarships received and used for 2020 is $26,730.00 don’t jive”.  You will reach a screen “Did Sam’s aid include an amount not used for 2020 expenses; Enter $5750.  Not doing this may explain the high ($10,341) taxable amount calculated.

Yes, the taxable amount of the 529 plan distribution will show up on Line 8, of Schedule 1 noted as 1009-Q taxable amount (or some such wording).  Total qualified expenses  less amounts paid by tax free 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 (using you numbers, as I understand them):
  $28,915 in educational expenses (15230 +4061 +8374 +1250)

   -$10,982 paid by tax free scholarship (26730-10028-5750)

   -$4000 used to claim the American Opportunity credit

 =$13,933 Can be used against the 1099-Q

Box 1 of the 1099-Q is $25000

Box 2 is $12074

13933 / 25000 = 55.7% of the earnings are tax free

55.7% x 12,074 = $6729

You have $5345 of taxable income (12,074-6729)

There are two questions you didn’t ask:

1. Can Sam file independent or is he  still Kent’s dependent?  

2. Is Sam eligible for the AOTC on his own return, even if he doesn't qualify as a dependent? 

I think the answers to both questions is no.  I'll explain in a separate reply.

[Hal_Al]

Q1. Can Sam file independent or does he still qualify to be Kent’s dependent?

A1. Probably not. The key is that scholarships (incl. ROTC) are third party support and not support provided by the student himself. Distributions from a 529 plan are support provided by the parent (the owner of the plan). The monthly stipend an ROTC cadet gets is tax free and treated as scholarship for the dependent support test.

 A child of a taxpayer can still be a “Qualifying Child” (QC) dependent, regardless of his/her income, if:

1. He is under age 19, or under 24 if a full time student for at least 5 months of the year, or is totally & permanently disabled
2. He did not provide more than 1/2 his own support. Scholarships are considered third party support and not as support provided by the student.
3. He lived with the parent (including temporary absences such as away at school) for more than half the year

So, it doesn't matter how much he earned. What matters is how much he spent on support. Money he put into savings does not count as support he spent on him self.

The support value of the home, provided by the parent, is the fair market rental value of the home plus utilities & other expenses divided by the number of occupants.

The IRS has a worksheet that can be used to help with the support calculation. See: http://apps.irs.gov/app/vita/content/globalmedia/teacher/worksheet_for_determining_support_4012.pdf

Q.2. Is Sam eligible for the AOTC on his own return?

A.2. Only if he does not qualify as a dependent and is over age 23. If he is a non-dependent, he qualifies for the non-refundable credit, regardless of age. There is even a provision that allows a parent to forego the student’s dependency (and the $500 dependent Tax credit) to allow the student to claim the non-refundable portion of the education credit. But Sam’s income ($13,080 + 5345 -12,400 = $6025 taxable) is so low that there is only a small ($6025 x 10% = $602 tax savings) benefit.

Whether a dependent, or not, a full-time unmarried student, under age 24, is only eligible for the refundable portion (the $1000) of the American Opportunity Credit if he supports himself by working. You cannot be supporting yourself on parental support, 529 plans or student loans & grants. It is usually best if the parent claims that credit. 

If he doesn’t qualify as a non-dependent, he also doesn’t qualify for the stimulus/Rebate credit. But, there is a provision (so far) that says he doesn’t have to pay it back if he already got it.

[3kidsincollege]

Intuit support board is awesome!  I have a follow-up question related to the support test. My confusion relates to how to handle third party support vs. support from student and parent.

1. Student receives scholarships that pay for the majority of tuition, fees, board.  These appear on 1098T.  This is third-party support as I understand it. 
2. Parents paid for some qualified expenses and were reimbursed via 529.  These are on the parent's 1099Q. This is parent support.
3. The student had a summer job and received 1099Q 529 distributions in their name and SS# due to scholarship (withdrawing funds without 10% penalty and being distributed directly to the student).  Total of these proceeds from W2 and 529 is ~$30K and taxable income portion is ~$18K.  Student is paying taxes on the 529 distributions.  The student used these funds (W2 and some of 529 distribution) to pay for their support not covered by #1.  This is student support.

My question:  considering out of pocket expenses for student support (i.e. all expenses for student not covered by #1), the student paid more than 50% of their support, using their W2 and taxable 529 distribution.  Does student meet the criteria for self-support?

[Hal_Al]

Q.  Does student meet the criteria for self-support?

A.  Simple answer: no. The reason is: the 529 distribution, in his name (his name & SS# as recipient) is still NOT student self support, because the parent is still the OWNER of the plan, even though the student is paying the tax on the excess distribution. 

That said, the answer is not clear cut.  The treatment of expenses paid with distributions from Sec. 529 plans and Coverdell ESAs in the support test is uncertain because of the dual nature of these college savings vehicles and a lack of IRS guidance. The consensus among tax experts is that it is parental support, because the parent is the owner of the plan.  Making distributions to the beneficiary (or school) is helpful to your case, but it's a not controlling factor. 

References:

https://www.savingforcollege.com/articles/the-impact-of-529-plans-on-claiming-a-dependent

http://www.aicpa.org/publications/taxadviser/2010/august/pages/nichols_aug-2010.aspx

[3kidsincollege]

Very helpful.  Thank you!  Just to be sure I understand the proper way to review support testing for different situations: (Please correct anything that is in error)

• Dependent vs. non-dependent determination is completed each tax year and can vary year-to-year for an individual student?
• 529 distributions direct to school are considered self-support provided by the beneficiary student?
• 529 distributions (taxable) to the student are undefined by IRS, but generally considered parent support (529 account owner) if funds are used for student support vs saved.  This is confusing as some CPA's present QTP taxable distributions to student as self-support.  Another example.
• Scholarships to student are excluded from support tests?  So it comes down if the student provided >50% of support for costs outside of those covered by scholarships.
• Sources of student funds that can be used for self-support.  W2 wages are clear, how about student's savings?  How are gifts handled? For example, money from relatives or parents to student that student then uses for their support?

Thank you!

[Hal_Al]

Q. Dependent vs. non-dependent determination is completed each tax year and can vary year-to-year for an individual student?

A. Yes. But, it would be rare for for it to vary back and forth.

Q.  529 distributions direct to school are considered self-support provided by the beneficiary student?

A.  No, because the parent is the owner of the account.  I revised my comment above, it was poorly worded and may have led to that conclusion.

Q.  529 distributions (taxable) to the student are undefined by IRS, but generally considered parent support (529 account owner) if funds are used for student support vs saved.  This is confusing as some CPA's present QTP taxable distributions to student as self-support.  Another example.

A. As previously stated the IRS has not issued guidance. "Some" say one way; "most" say the other way.

Q. Scholarships to student are excluded from support tests?  So it comes down if the student provided >50% of support for costs outside of those covered by scholarships.

A. Simple answer: yes.  Again, there appear to be two interpretations: 1. scholarships are ignored and are not part of the calculation or 2. Scholarships are 3rd party support and are part of the calculation. "Most" experts  favor #1

Q. Sources of student funds that can be used for self-support.  W2 wages are clear, how about student's savings?  How are gifts handled? For example, money from relatives or parents to student that student then uses for their support?

A. Savings yes.  Gifts, no. But, yet  again, it could be.  It depends on intent.  Real gifts are the student's self support.  Giving the student money, for his tuition, is not a gift, it's paying his tuition.