Q. It seems like the basis is not taxable which is why earnings are calculated.
A. That's correct.
Q. Is the 10% penalty applied to the $2150 of earnings?
A. Yes. In addition to the penalty, the $2150 would be taxed at you marginal tax rate. That assumes the whole $5000 distribution was non qualified.
You indicated that only some of the distribution was non qualified. Taking the example further, let's say that only $1000 (of the $5000 2021 distribution) was not used for qualified expenses (tuition, fees, books and computer, room and board). 1000 / 5000 = 20%. Only 20% of the $2150 ($430) is taxable and subject to the 10% penalty. TurboTax is capable of doing that calculation, but it can get tricky.
You put in $20,000 over the years. In 2021, you took out $5000 and had a year end balance of $30,000.
20,000/(30,000 + 5000) = 57% is basis, 43% is earning. 43% x $5000 = $2150 of your 2021 distribution was earnings.
