Scholarships, 529 Plan, and Newly Independent Graduate

[jandk]

In November, 2023, we paid our son's tuition for Winter 2024, and also received reimbursement from the 529 Plan that we had established for our son (the beneficiary).  In March 2024, our son received a $6,000 scholarship for Winter 2024, which was sent to his university.  His university sent us (his parents) a $6,000 refund check in March 2024 with the description Winter 2024.  We immediately re-contributed the $6,000 refund to our 529 plan for our son.  Further complicating the situation, our son graduated, became employed, and will not be our dependent for 2024 tax purposes.  He received a 1098-T with $0 in Box 1 (Payments received for qualified tuition and related expenses), $0 in Box 4 (Adjustments made for a prior year), $6,000 in Box 5 (Scholarships or grants), and $0 in Box 6 (Adjustments to scholarship or grants for a prior year).  How should we handle this in TurboTax on our son's taxes and on our taxes so that his $6,000 scholarship, which was used to cover part of his tuition, is not seen as taxable income?  How should we handle the 2024 re-contribution of $6,000 to our 529 plan for 2024 tuition reimbursed in 2023?  We did not receive a 1099-Q for our son's 529 plan this year, as we had no withdrawals.  Do we need to file an amended 1040 for 2023?  The $6,000 scholarship/re-contribution was far less than the tuition we paid in 2023, and would not result in any taxable income for us or our son.  Thank you for your help!

[Hal_Al]

"Our son graduated, became employed, and will not be our dependent for 2024 tax purposes."

All of that is irrelevant for your situation. The beneficiary of the 529 plan does not have to be the owner's dependent.

The re-contribution to the 529 plan must be within 60 days of the distribution or within 60 days of receiving a refund from the school, to be valid.

So, the answer depends on why you got the refund. Was it a refund of the scholarship or a refund of the expenses you paid.  If it's a refund of expenses, your 2023 distribution is still considered a qualified distribution and you don't need to do anything.  Likewise, the student can consider the scholarship money as having paid for tuition (a qualified expense) and it is tax free. 

If it was the scholarship that was refunded then you need  file an amended 2023 return to report the non qualified distribution or your son must treat the scholarship as taxable or a some of each. You may have to do math to determine the best outcome for the family.  Although you may have to pay tax on the distribution, you qualify for the scholarship penalty exception.  The distribution amount (box 1 of the 1099-Q) is not the taxable amount. The taxable amount is the earnings in box 2.*

That said, you only mention the 2024 tuition expense. Room & board, books and a computer are also qualified expenses for a 529 distribution.  You cannot count 2024 R&B for a 2023 distribution, but you can count 2023 R&B. Books and a computer, paid for in 2024, are qualified expenses for the scholarship. 

*Example: Box 1 is $10,000, box 2 is $5000.  Because of the $6000 scholarship, only $4000 of the box 1 amount is now qualified.  $6000 is a non qualified distribution.  6000/10,000 = 60%.  60% of the box 2 amount is taxable.  60% x $5000 = $3000 taxable income on your 2023 return vs. $6000 taxable scholarship on his 2024 return. 

[jandk]

I've continued to grapple with our questions regarding our son's scholarship, our 529 plan, and our taxes, as it just didn't seem fair that our son or his parents (us) would have to pay taxes on a scholarship which we didn't learn about until March 2024, didn't receive scholarship funds for until March 22, 2024, and was used for January through April 2024 tuition, when the amount previously withdrawn from our 529 Plan was a Qualified Withdrawal and was re-contributed to the 529 Plan fund for which our son is a beneficiary on April 1, 2024, well within 60 days of the receipt of the scholarship funds.  Here is what I found with regard to the Michigan Education Savings Program 529 Plan.

From page 31 of the SUPPLEMENT 2 DATED APRIL 1, 2024, TO THE MICHIGAN EDUCATION SAVINGS PROGRAM PROGRAM DESCRIPTION AND PARTICIPATION AGREEMENT DATED JUNE 09, 2023, AS SUPPLEMENTED:

“Refunds of Qualified Higher Education Expenses. If an Eligible Educational Institution refunds any portion of an amount previously withdrawn from an Account and treated as a Qualified Withdrawal, such amount will not be subject to federal and possibly state and/or local income tax if it is recontributed to a qualified tuition program for the same Beneficiary not later than 60 days after the date of the refund. If the amount of the refund is not recontributed within 60 days, the amount of the refund potentially may still be treated as a Qualified Withdrawal if the refund is used for Qualified Higher Education Expenses or may be treated as a Non-Qualified Withdrawal or a Taxable Withdrawal, depending on the reason for the refund. You should consult with a qualified advisor regarding how the rules apply to your circumstances.”

Would I be correct in thinking that under these circumstances, our son does not have to pay taxes on his scholarship and we do not have to file amended taxes for 2023?  Any advice you can give us on how to handle this on Turbotax would be greatly appreciated.

[Hal_Al · Accepted solution]

Q. Would I be correct in thinking that under these circumstances, our son does not have to pay taxes on his scholarship and we do not have to file amended taxes for 2023?

A.  Yes.  My original interpretation of your situation was that the school had simply forwarded the left over scholarship money to you.  Your interpretation that it is, instead,  a refund of expenses, you previously paid,  appears to be on solid ground; particularly since the school  "sent the parents (not the student) a refund check with the description Winter 2024." I would go for it. 

You are correct, if you receive a "refund", you can redeposit the money within  60 gays from the date of the refund to undo the distribution. IRS Publication 970 has similar wording to your source:

"If a student receives a refund of qualified education expenses that were treated as paid by a QTP distribution, the student can recontribute these amounts into any QTP for which they are the beneficiary within 60 days after the date of the refund to avoid the need to figure the taxable part of the QTP distribution."

[jandk]

Thank you, thank you, thank you!