Q. How do I make $3500 of the 1099-Q distribution taxable to claim the full AOC?
A. You don't make $3500 of the distribution taxable. You make $3500 of it non-qualified, by allocating $3500 of the tuition to the AOC. TurboTax (TT) will then make a portion of the earnings, in box 2 , of the 1099-Q taxable.
The TT interview handles this automatically (theoretically). But, you have to follow the interview carefully. Mistakes are frequent. In particular, enter the 1099-Q before entering the 1098-T. Also, be on the look out for a screen “Amount Used to Calculate Education Credit” or a screen "Choosing a larger education credit or deduction". Verify the number used is $4000 or change it. TT will then calculate the taxable amount of the 529 earnings and even apply the penalty exception.
Room and board are qualified expenses for the 529 distribution (but not for the AOC or tax free scholarship), even if the student lives at home.
