Education

Q. 1. Since the totals are less than the $4000 available for calculating the AOTC, is Turbo Tax correct in allowing her to tax the 529 to take the credit?

A.2. Yes

Q .2. In other income, it shows $1114 instead of $2861 or $1171.  How does it determine this amount?

A.2. $1171 is the correct amount .  The math is: the non qualified portion of the distribution divided by the total distribution (determines taxable percentage) times the box 2 amount. So, in your case 100% of box 2 is $1171

Q. 3. I thought books were allowed for the AOTC, but Turbo Tax did not include the books in its calculation.  I tried another tax software, and it included the books.  Which program is correct? 

A. 3. Books are allowed if Required for attendance. TT gives you 2 boxes to enter book costs. Enter at Required.  A computer is (usually) also a qualified expense. 

Q. 4. Does the $1114 go in the Michigan return line that asks if the 529 amount was included in AGI? 

A. 4.  Yes. I'm not familiar with the MI program/tax rules. But, the answer to the question "was 529 amount  included in federal AGI" is yes.

More issues:

1. How much earned income does the student  have?  A  FT student under 24 is not eligible for the refundable portion of the AOTC unless she supports herself by working.

2. Does she have any scholarship (box 5 of the 1098-T)?  That will change her reportable income. 

3. You don't mention any room and board.  Room and board are qualified expenses for a 1099-Q (if she is a half time or more student), even if she lives at home. A computer is also a qualified expense. Surely she has $2861 of food expenses for the year.  If so, just don't enter the 1099-Q at all.  

When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms.  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." 

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Qualified Tuition Plans  (QTP 529 Plans) Distributions

General Discussion

It’s complicated.

For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q. 
The 1099-Q gets reported on the recipient's return.** The recipient's name & SS# will be on the 1099-Q.
Even though the 1099-Q is going on the student's return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because he is your dependent.

You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The educational expenses he claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit,  that gets him an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. Another special rule allows you to claim the tuition credit even though it was "his" money that paid the tuition.
In addition, there is another rule that says the 10% penalty is waived if he was unable to cover the 529 plan withdrawal with educational expenses either because he got scholarships or the expenses were used (by him or the parents) to claim the credits. He'll have to pay tax on the earnings, at his lower tax rate (subject to the “kiddie tax”), but not the penalty.

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:
  $10,000 in educational expenses(including room & board)

   -$3000 paid by tax free scholarship***

   -$4000 used to claim the American Opportunity credit

 =$3000 Can be used against the 1099-Q (usually on the student’s return)

Box 1 of the 1099-Q is $5000

Box 2 is $2800

3000/5000=60% of the earnings are tax free; 40% are taxable

40% x 2800= $1120

You have $1120 of taxable income  

**Alternatively; you can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip!  When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.

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." 

***Another alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit. Most people come out better having the scholarship taxable before the 529 earnings.