Why am I getting the American Opportunity Credit? The tuition was paid in full by withdrawals from a 529 QTP plan. I thought I couldn't use both for the same expenses?

[KrisD]

You can't, but did the program tax the distribution to give you the credit instead? Who was issued the 1099-Q, the owner or the student?

[tzatorski929]

Yes, the program added the earnings amount of the distribution under the "other income" section.  We received two 1099q forms.  One went to my son for one withdrawal and one to myself for the other withdrawal. It only made me report the one addressed to myself.  

[KrisD · Accepted solution]

If education expenses can be applied to a 1099-Q distribution OR an education credit, the program will allocate the expenses so that it results in a lower tax liability (or higher refund) for the taxpayer. 

The 1099-Q distribution is only taxed on the interest/earnings, and if the reason the distribution is not applied to the education expenses is so that the taxpayer gets the credit, there is no penalty tax on the distribution. 

The person that is issued the 1099-Q (student or owner) is liable to pay the tax. 

If the tax for the student does not cause the student to meet the filing requirements, they do not need to file a return. 

CLICK HERE for IRS Pub 970 Tax Benefits for Education

[tzatorski929]

If this is true, then why did the tax program reduce my refund when I entered in my 1099q.  My earnings on the 529 were $209 and it reduced my federal refund by about $70 and my state by about $10....when I entered the info off of my 1099q.

[KrisD]

Did you enter the 1099-Q before reporting the 1098-T? If so, the program will first tax (with penalty) the distribution. Once the 1098-T is entered, the program adjusts.

[tzatorski929]

I tried both ways and it still penalizes me. I have read that others have experienced the same issue.

[KrisD]

It will be taxed in both situations, but are you saying that the 10% penalty is applied after the 1098-T is entered? When you say the tuition was "paid in full" by the distribution, was it even? Distributions plus scholarships equal tuition and fees?
For example, if tuition was 10,000 and distributions were 10,000, and you take 4,000 for the credit, you should be taxed on the earnings of 4,000.
If tuition was 10,000 and a scholarship on Box 5 was 2,000, and the distribution was 10,000, and you take 4,ooo for a credit, you will be taxed on 6,000 and penalized on 2,000 because there was only 8,000 of tuition after the scholarship applied.
Same example, but you allocate the 2,000 scholarship to Room and Board, the student will need to claim the 2,000 as income and you are taxed on 4,000 and no penalty.
If you tell us all the numbers, (the 1098-T and 1099-Q) we can give a better answer. The American Opportunity Tax Credit needs 4,000 for the full credit. if the distributions plus scholarships are more than 4,000 above the education expenses (tuition and books) there will be a penalty. But the tax, including the penalty, should be less than the credit if you clicked "Maximize my Credit" in the education section.

[tzatorski929]

Yes, the qualified expenses and the 529 distribution were exactly even.  We had no other expenses above and beyond this.

[KrisD]

Qualified expenses are only tuition and fees. Not room and Board, and there were no other tax free assistance, such as scholarship, and you had tax AND penalty tax on the distribution?

[tzatorski929]

Yes, we do not get any scholarships or financial aid or grants.  The qualified expenses were tuition and required text books.

[KrisD]

And you are sure you are being TAXED and ALSO the penalty tax? If so, I will forward this.

[tzatorski929]

I don't see any other explanation for it to reduce my refund by that $70 when I enter the 1099q.  As soon as I delete to 1099q it gives the $70 back to me.

[KrisD]

You can look at the earnings on the 1099-Q. If the distribution was 8,000 and the earnings were 638, you would be taxed on 318. At 22% that tax would be 70, which is correct.

[tzatorski929]

The distribution earnings were $209.  my refund decreased by $72 for federal and $9 for state.