Education

I'm filling out my son's tax return. He's a senior in college, still a dependent on my return, but he's got some earned income from a summer job, and a relatively small amount of dividend and capital gains income from an E-Trade account.

Bottom line is, your son will file his own tax return to report that income.No exception here.

His income is such that he gets a refund of all withheld taxes from his summer job, and no taxes owed on his investment income. So far, so good.

Yep. Now comes the "but". 🙂

But...he's got a 1099-Q showing $37,000 in distributions from his 529 account, as well as a 1098-T from his college showing $25,000 in scholarship money and $45,000 in tuition payments.

Bottom line with no exception here. If the 1099-Q has the student's SSN in the recipient's box, then *IF* the 1099-Q is required to be reported, (I stress *IF*) the student has no choice and must report that 1099-Q on the student's tax return.

So, $45K in tuition minus $25K in scholarships leaves $20K in tuition.

I'm with you so far.

That $20K plus $15K for room and board plus another $2K for books and supplies adds up to $37K which should completely offset the 529 distributions.

So the reality is, there is a total of $62,000 of "third party income" received from other sources. $37K in 529 distributions added to $25K of scholarships gives a total of $62,000 of "third party support" provided to the student. Keep this number in mind.

The student has $37K in qualified education expenses (tuition, books and lab fees) and another $15K for the unqualified but allowed expense of room and board that was paid "in direct support" of the education. That gives a total of $52,000 in deductible expenses for education.

Since $62,000 in third party support was received in 2019 and only a total of $52,000 of that was used to pay for qualified education expenses and "allowed" expenses, that means there's $10,000 of taxable income remaining.

Therefore, while you will still claim the student as your dependent, it is the student who will report "ALL" of the education stuff on their tax return. It is the student that will pay taxes on the excess $10K of third party support. Additionally, the student will be taxed at the higher, parents' tax rate on that $10K only.

TT tells me he's not eligible for an education deduction or credit because either a) I can claim him as a dependent on my return,

..and that is a true statement.

b) distributions exceed the education expenses (which they don't),

Unless I missed something, using your numbers the third party support received by the student, exceeds the total of all the qualified education expenses and the allowed education expenses of room and board.

c) there were no net qualified education expenses (which there were).

I don't see any qualified out of pocket expenses at all here. Remember, out of pocket money can not be used for room and board. Neither can scholarships. Only 529 funds can be used tax free for room and board.

Here's the scenario of how the IRS prioritizes and applies this stuff.

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First, scholarships & grants are applied to qualified education expenses. The only qualified expenses for scholarships and grants are tuition, books, and lab fees. that's it. If there is any excess, then it's taxable income to the student. It automatically gets transferred to and included in the total on line 7 of the student's 1040.

Next, 529/Coverdell funds reported on 1099-Q are applied to qualified education expenses. The qualified expenses for 1099-Q funds are tuition, books, lab fees, AND room & board. That's it. If there are any excess 1099-Q funds they are taxable. The amount is included in the total on line 7 of the student's tax return..

Finally, out of pocket money is applied to qualified education expenses. Out of pocket expenses can only be used for tuition, books, and lab fees. That's it. Out of pocket expenses can not be used for room and board.

When you have a 1099-Q it is extremely important that you work through the education section of the program in the order it is designed and intended to be used. If you do not, then there is a high probability that you will not be asked for room & board expenses, and you could therefore be TAXED on your 1099-Q funds.

Finally, if "all" qualified expenses are covered by scholarships, grants, 1099-Q funds and there is ANY of those funds left over, the left over excess is taxable. While the parent can still claim the student as a dependent, it is the student who will report all the education stuff on the student's tax return. That's because the STUDENT pays the taxes on any excess scholarships, grants and 1099-Q funds.