Yes. You can still claim a tuition credit, even though you used ESA money. Some of the ESA may be taxable, but the tuition credit more than makes up for it.
Qualified Tuition Plans (QTP 529 Plans) and Coverdell ESA
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 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 even though it was "his" money that paid 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)
-$3000 paid by tax free scholarship***
-$4000 used to claim the American Opportunity credit
=$3000 Can be used against the 1099-Q (usually on the student’s return)
Box 1 of the 1099-Q is $5000
Box 2 is $600
3000/5000=60% of the earnings are tax free
60%x600= $360
You have $240 of taxable income (600-360)
**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.
Yes. You can still claim a tuition credit, even though you used ESA money. Some of the ESA may be taxable, but the tuition credit more than makes up for it.
Qualified Tuition Plans (QTP 529 Plans) and Coverdell ESA
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 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 even though it was "his" money that paid 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)
-$3000 paid by tax free scholarship***
-$4000 used to claim the American Opportunity credit
=$3000 Can be used against the 1099-Q (usually on the student’s return)
Box 1 of the 1099-Q is $5000
Box 2 is $600
3000/5000=60% of the earnings are tax free
60%x600= $360
You have $240 of taxable income (600-360)
**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.
My son is in community college, when I enter the 1098-T, it gives me the education credit. But his tuition costs were covered completely with Coverdell distributions and scholarships. How should I enter so my return is correct? Please confirm, thanks so much!
Jen
Jen,
Provide the following info for more specific help:
Hi! Thanks for your fast response, I actually have the school looking into some numbers on the 1098. He took some of these college classes in high school and there may be an error in box 1 by about a six hundred dollar overage. Regardless, the issue remains the same overall.
You do qualify for the tuition credit. You don't need any further research by the school about the scholarships.
$6353.50 - 1740 = $4613.5 which is more than the $4000 needed to claim the maximum AOC credit. A $600 error won't change that.
The fact that box 2 of the 1099-Q is 0, means you do not need to report the distribution from the Coverdell. You have 0 earnings, so nothing is taxable. Essentially the distribution did not get used for education, so you can apply all the expenses to the credit
Thanks again, this is so interesting. I apologize for my questions if repetitive but want to make sure I am understanding correctly. I realize the error may not make a difference. But what if my son received a distribution of 4998.50 to cover all of these expenses, I don't feel like I would get the education credit since it is completely covered. Am I missing something? The 1099 is in his name, and he is not employed currently if that is helpful information.
Thanks!
The fact that box 2 of the 1099-Q is 0, means you do not need to report the distribution from the Coverdell. You have 0 earnings, so nothing is taxable. Essentially the distribution did not get used for education, so you can apply all the expenses to the credit
The fact that the Coverdell (ESA) distribution went to your son, rather than you doesn't change the answer.
" I don't feel like I would get the education credit since it is completely covered."
Look at it this way: you/he took money out of your plan. You get to decide what you use the money for. If you decide not to use it for education (and that is essentially what you are doing), then it becomes taxable. But since box 2 is 0; the taxable amount is also 0. Since you know the taxable amount is 0, you do not have to report the distribution.
When the taxable amount is 0, TurboTax will enter nothing about the 1099-Q on the actual tax forms. So, don't risk making a mistake: don't enter the 1099-Q in TT.
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."
Hi again! So after I spoke to the my financial adviser this issue came up again regarding the Coverdell distributions and tax credit. I looked again and found this post which does not seem to be in alignment with what we discussed previously.
Note that "Fern" is a "new member", not an expert, employee, Champ or high level member. His answer, while essentially correct, is subject to interpretation.
You can not use the same expenses to qualify for an education credit, tax free scholarship and/or tax free ESA/529 distribution. But, you are basically free (some limitations) to allocate those expenses to whichever tax break(s) you want to claim.
That said, it doesn't matter in your case: box 2 of the 1099-Q is 0. It's the first and only time I've seen that, in this forum, although it's very possible (unusual doesn't mean it's wrong).
This does assume that box 2 of the 1099-Q was actually 0 (not blank) and the amount in box 3 was 4998.50 (not blank or 0).
Thanks, I did not realize that. If his total tuition after scholarships is about five thousand, and we took a five thousand dollar distribution it would seem these are the same expenses (there is not room and board or anything above that).
Upon rechecking my 1099 box 2 says blank not zero (my error). Box 3 is also blank.
So I think I cannot claim the tuition credit since all expenses are covered. Do you agree?
Thanks,
Jen
Q. So I think I cannot claim the tuition credit since all expenses are covered. Do you agree?
A. Yes and no. Yes, on the surface, that is correct. But there are ways around it .
First, I disagree that there is no room and board or anything above that. If he is living at home, he can't count "room" unless he is paying you rent (and maybe not even then). But he can count food (board). You can keep track of food expenses or use the school's meal plan cost for on campus students
Since the tuition credit is worth as much as $2500, you want to claim it first even if it means paying some tax on the ESA distribution and/or scholarship.
You'll have to calculate the earnings portion of the distribution, since the plan administrator didn't provide it. You do this from your own records. If boxes 2 & 3 were blank, some where on form 1099-Q they tell you the Fair Market Value of your account, which may or may not be helpful in that calculation.
OK, I will look into this-it does seem to be the better choice with such a significant credit.
Thanks,
Jen
Hi!! Just following up as I am slowly understanding this calculation. I did indeed claim the tuition credit first on my return. Now to file for my son who currently has no income but will now have to pay on the portion of the distribution that is no longer tax free (he is the beneficiary and his SS# is on the 1099- Q).
I have worked through the Coverdell ESA-taxable distributions and basis worksheet multiple ways and am complete. The one question I have is in Part II. Line 2 where it says, "enter your basis in this Coverdell as of 12/31/2019?" We contributed 2,000 to this account about many years ago and never contributed again and took the first disbursement in 2020. So is the basis only that money (2,000) since it was the sole contribution and before 2020, or it the total amount of the account as of 2019 (which is mostly earnings which I think are tax free)?
Thank you!!
Jen
There is a box on the 1099-Q:
"If the fair market value (FMV) is shown below, see Pub. 970,
Tax Benefits for Education, for how to figure earnings" (page 53)
Was there anything in that?
Your original basis was $2000. You have to calculate how much of that $2000 was included in the current $4998.50 distribution. You do that by noting how much was still in the account on 12-31-20.
The fair market value has the total amount which is about 24,000. So per the worksheet 7-3, p. 58 I added the distribution (about 5,000) plus the fair market value which gave me line 8 (total of 29,000). Then I divided the original basis of 2,000 (since no contributions have been made) by that total of 29,000. I used this number and multiplied it by the distribution (5,000) to determine the amount of basis allocated to to the distribution which is tax free. Does that sound correct?
Thanks!
Yes, that is correct. That sounds like the basis portion of the $5000 ($4998.50) is about $345, making the earnings about $4655.
Have you been able to come with the school's meal plan charge, so that we can use some of the ESA for "board"?
Since we now know the ESA distribution did have earnings (actually almost all earnings) it's not tax free, unless we come up with some more expenses to allocate to it.
Here's where we're headed (I think):
1. You will use $4000 of the expenses to claim the AOTC
2. You student will declare the $1740 scholarship to be reportable income, freeing up more expenses for the ESA distribution. The $1740 will not actually be taxed unless your student has more than $10,000 other income to report.
3. We need to determine the taxable portion of the ESA. If "board" is more than about $2350, none of the ESA distribution will be taxable.
Hi...think I understand. The estimated cost for board for a full time student is "2,300" per his college's website. So I would need to remove the scholarship from my tax information and add the board to the QEE, and then file his scholarship money as income on his tax return? The total of qualified educational expenses would be higher (roughly 8,600) and the Coverdell could count toward this with less being taxed, or almost none with the board cost included? That is such a creative solution-wow! Is that correct?
Thanks!
Yes, that is fundamentally correct. TurboTax is capable of handling it all, but the interview is complicated. I recommend using some short cuts.
1. You will use $4000 of the expenses to claim the AOTC.
The simplest thing is to modified the 1098-T. I would enter $4000 in box 1 and leave box 5 blank. Lying to TurboTax to get it to do what you want does not constitute lying to the IRS. Don't enter any other numbers.
2. You student will declare the $1740 scholarship to be reportable income, freeing up more expenses for the ESA distribution.
Does your student have any other income? That is, if it wasn't for having to report the scholarship and 1099-Q, would he even have to file a tax return? The shortest short cut is for him to not file a tax return, at all. We don't know exactly how much of the 1099-Q will be taxable, but I'm pretty sure it will be under the $350 filing requirement (assuming we use the $2300 board allowance). That said, some people recommend you file anyway, to document the fact that he is counting the scholarship as income (allowing you to claim the AOTC).
3. We need to determine the taxable portion of the ESA.
You have $6354 tuition + $300 books + $2300 board = $8954 Total expenses less $4000 used for the AOTC = $4954. That is only $45 less than the $4999 ESA distribution. Using your basis fraction, that works out to $42 taxable. I think that's small enough to ignore, since it won't actually get taxed (his standard deduction covers it).
If you do deicide to have your student file and need instructions on a short cut entry method, let me know.
Thanks, I did change the 1098 within Turbo Tax, and removed the scholarship.
No, he would not have filed without this change. He will probably file for this year to claim the scholarship as recommended, if you do not mind I would appreciate instructions on the shortcut entry.
I am also adding to his educational expenses the purchase of a laptop for $650 that he needed for college classes (8954+650=9604). Now the total will be well above the distribution so none should be taxable.
Thank you!
Jen
You are correct, the purchase of a lap top is an eligible expense for an ESA distribution.
Confirming your calculation: You have $6354 tuition + $300 books + $2300 board + $650 computer = $9604 Total expenses less $4000 used for the AOTC = $5604. 5604 - $4999 ESA = $605 can be claimed for the scholarship. So, the taxable amount of the scholarship is now 1740 - 605 = $1135.
Short cut: Do not enter the 1099-Q at all. The ESA distribution is totally covered by expenses*. At the 1098-T screen, on the student's return. enter $1740 in box 5 and $605 in box 1. (Alternate: put 1135 in box 5 and 0 in box 1). Enter no other numbers. TurboTax will put $1135 on line 1 of form 1040 with the notation SCH. The student-dependent's standard deduction will be 1135 + 350 = 1485. So, there will be no tax. In the personal info section, be sure you indicate the student can and will be claimed as a dependent.
Be sure to keep a record of these calculations in case of an IRS inquiry.
*Even if you entered all the ESA data, 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.
OK, thank you so much for all of information. It was incredibly helpful.
Thanks,
Jen
I have a similar question. I followed how to handle parent/dependent student breakouts (which you clarified on another thread before I found this one). But I have an additional question regarding the 1099-Q.
Some background: Snail mail messed up our plans. College bill was due early January, so we requested the ESA money in mid-December, but it didn't arrive in time to pay the college in December. We did the rollover (indirect back into the same account) in the 60 day period to avoid getting hit with taxes/penalties, fearing we would not have nearly enough expenses to cover what was 'distributed' in 2020 vs. costs actually PAID in 2020. The Basis and Earnings boxes were blank, so I followed the process outlined in this thread. ... except I did it using #'s where the rollover is accounted for, rather than what is actually on the 1099Q. Fear explaining poorly.
Dist 1: $3830
Dist 2: $3287 (Dec 2020)
Dist 2 was fully re-invested by indirect rollover within 60 days
1099Q as received shows:
Gross Dist: $7117
Earnings: blank
Basis: blank
FMV: $8037
So in the 1099Q info request in TT I put:
Gross Dist: $7177
Earnings: $2384
Basis: $1445
and wherever it asks about FMV: $11,324
But I figured Earnings, Basis, and FMV based on the rollover being done. Is that right? Of do I figure Earnings and Basis and enter FMV based on what is actually on the form since the rollover is asked about in follow up questions?
Thanks!
@Hal_Al Based on the discussion here, I am inclined not to include my daughter's 1099-Q from her Coverdell distribution in Turbotax. Can I put the numbers in this thread? Or should I start a new question? Thanks.