Why does TurboTax calculate a tax liability even though 1099-Q distribution amount is less than 1098-T qualified education expenses?

[anton_magid]

I claim my son as a dependent on my tax return and he is a full time student as well as is a recipient of 1099-Q form. When I tried to file his tax return, I found out that TurboTax calculates a tax liability for him even though the 1099-Q distribution amount ($57,000) is less than the qualified education expenses ($61,000) reported in 1098-T form. Looks like it is happening because of a decomposition of 1099-Q Gross Distributions ($57,000) into Earnings ($14,000) and Basis ($43,000) So, it seems like it is not enough for Gross Distributions to be equal or less to 1098-T Expenses to calculate no tax liability which does not make much sense to me. Can anybody please help me understand why and how the split between Earnings and Basis in 1099-Q impacts the tax calculation?

[JillS56]

 No, the split between the earnings and the basis of the 1099-Q is not used in calculating taxability.   The distribution from the 529 plan is considered tax-free unless they are not used for qualified education expenses.   

The reason there are taxes being calculated has to do with the 1098-T and the 1099-Q.  Funds distributed from a 529 Plan, will be reported by the bank on Form 1099-Q.   The 1099-Q is sent to the owner/recipient of the 529 Plan funds.   The Form 1099-Q is to be reported as income if they were not used to pay qualified college tuition/expenses.    If the amount reported on the 1099-Q were used to cover qualified college tuition/expenses you do not need to report the income.  If the amount exceeds the amount of college tuition/ expenses then the excess needs to be reported as other income on your 1040.   Here is an article that talks about What is IRS Form 1099-Q.   Reporting 529 Plan

The 1099-Q and the 1098-T are forms that do not have to be reported on your tax return or your son's.   If you are claiming your son as a dependent, then he cannot claim the education credit and by reporting the 1099-Q on his return, it is going to cause a tax liability as the entire amount of the 529 distribution is going to be considered income.   Based on the information provided, it does not appear that either you or your son would be able to claim the education credit.   You cannot take an education credit when you have sufficient funds from the 529 plan to cover the qualified educational expenses.    

 If the 1099-Q distribution is enough to cover the tuition, room and board, other expenses, and Box 1 of the 1098-T is more than Box 5, then you might not want to report the 1098-T or the 1099-Q as this will create excess income and you will have to report the income as other income.   The 1099-Q does not have to be reported, but it does need to be taken into consideration and if you are going to attempt to get the AOTC credit, then you do need to report the 1099-Q on your taxes, which in your case, comes out that you owe income.  The 1099-Q should also be reported if the distribution was more than your tuition, room and board, etc.    

As long as the 529 distribution was used to pay for qualified educational expenses and does not exceed the 529 distribution and the scholarship funds, It sounds to me like you may not want to report either the 1099-Q or the 1098-T on either tax return as it appears that it is going to create a tax liability.   

[anton_magid]

I entered 1099-Q and 1098-T in my son's tax return and even though he is a full time student and 1099-Q Gross Distributions > 1098-T Box 1 Amount, TurboTax calculated $39 tax liability (when I reduced Earnings and increased Basis for testing purposes only, it calculates a 0 tax liability - that's why I thought that Earnings/Basis decomposition matters.) Also, my son has income of $1,800 as a teaching assistant, but this income is below a threshold for filing taxes anyway. But TurboTax does not seem to be smart enough to identify this situation as a 0 tax liability. So, do I have to file a tax return for my son or because 1099-Q gross distributions > 1098-T Box 1 and his income is below the threshold, I don't need to bother filing a return for him?

[JillS56]

Since you are claiming your son, the 1098-T should not be reported on your son's return as he is not eligible for the education credit.  Also, do not report the 1099-Q since this will only result in a tax liability on the full amount, because as you stated earlier it is causing a tax liability for your son and both of these forms are not required to be reported on his return.  

As I stated before, the Earnings/Basis decomposition does not have anything to do with the tax liability being calculated.   The 529 distribution which is shown on the 1099-Q is tax-free as long as the distribution is used for qualified educational expenses.   The only reason you are provided the earnings/basis on the 1099-Q is in the event that you do have to report the distribution as income as it was not used towards qualified educational expenses or a portion of the distributions was not used towards qualified educational expenses. 

Based on what you have shared, it does not appear that your son needs to file a tax return.  

[Hal_Al · Accepted solution]

Q. So, do I have to file a tax return for my son or because 1099-Q gross distributions > 1098-T Box 1 and his income is below the threshold, I don't need to bother filing a return for him?

A.  That's correct.  He does not need to file a tax return. 

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." 

[anton_magid]

Thank you!