Q1). Do we get the $2500 credit?
A1). No. But, yes.
41K -22k =19K which is fully covered by the 19K 529 plan distribution. It appears that there are no expenses left for the tuition credit. But the tuition credit is so generous ($2500 for $4000 of expenses or $2000 for $2000 of expenses) that you are better off paying some tax on the 529 distribution.
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:
$41,000 in educational expenses(not including room & board, more on that later)
-$22,000 paid by tax free scholarship
-$4000 used to claim the American Opportunity credit
=$15,000 Can be used against the 1099-Q
Box 1 of the 1099-Q is $19,000
Box 2 is $7000
15,000/19,000 = 79% of the earnings are tax free
79% x 7000 = $5526
You have $1474 of taxable income (7000 -5526)
$1474 x 12% tax rate = $177 in tax or 1474 x 22% = $324. Compare that to $2500
The 10% penalty for a non qualified distribution is waived because the $ difference was used to claim a tuition credit and/or was covered by scholarship.
The other obvious option is just take out $4000 less from the 529 plan. Then nothing is taxable, for now.
Q 2) .You keep mentioning Room and Board but she is a commuter living at home...not sure how that impacts the $2500 credit.
A 2), Room and board counts for a 529 plan distribution. You can count your actual cost to live at home or the amount the school charges an on-campus resident; whichever is less. The board part is fairly easy. I've seen some posters recommend you charge her rent to solidify the room part. In your case board alone is probably enough to use up $4000.
Q 3). Does the 1099Q Basis / Earning in any way factor into the $2500 credit?
A 3). See Q/A 1
I agree, you should transfer his 529 plan to a plan for her. If he goes back to school, you can transfer it again, back to him (must be more than 12 months after the 1st transfer)
