Yes, you are understanding it correctly.
Does Total qualified expenses of $47,500 include room and board, books and computer? You can count those.
Q. Does that mean on my return, I report the $1500 1099-Q and list $5500 of the tuition expenses to cover the $1500 from the State 529 and the $4000 needed for the credit?
A. Yes. But, if your income is in the $160K-180K phase out range, you may want to only claim $2000 for the AOC, instead of $4000. The first $2000 gets you 100% (before phase out). The 2nd $2000 is only worth 25%.
Q. On my son's return, list $42,000 in remaining qualified expenses (so as not to double dip) and then have $4,000 of the scholarship (or withdrawals) be taxed as income?
A. Yes. Depending on his other income, taxed scholarship is usually best. It's not the withdrawal amount that gets taxed, it's only the earnings portion.
Q. Lastly, I'm considering seeing if it is more advantageous to not treat him as a dependent - his income is significantly lower so should be able to take a full AOC.
A. If he qualifies as your dependent, he cannot file as independent. He MUST check the box that says he can be claimed as a dependent.
While technically there is a provision that allows your student-dependent to claim a federal tuition credit, from a practical matter it seldom works out. A student, under age 24, is only eligible for the refundable portion of the American Opportunity Credit (AOTC) if he/she supports himself by working. Hee cannot be supporting himself on student loans & grants and 529 plans and parental support. It is usually best if the parent claims that credit.
If the student actually has a tax liability, there is a provision to allow him to claim a non-refundable tuition credit. But then the parent must forgo claiming the student as a dependent, and the $500 other dependent credit. The student must still indicate that he can be claimed as a dependent, on his return. This is worth up to $2500 (AOTC shifts to all non refundable)
Q. If I did that, given I still have a 1099-Q in my name for $1500, I assume I should take that much of the qualified expenses and leave him the rest?
A. Yes
Q. He is going to have to file 3 different state returns, so I not sure if this will be a complication?
A. It depends on the states, but it's unlikely to make any tax difference. It just makes filling out the forms harder
