Q. So I don't see how I can have any qualified expenses left for which to claim the AOTC. And if I just say well I'm paying the tax on the 529 disbursements so I don't double-dip, I still don't understand how that can really work because we did in fact use those funds to pay the educational costs?
A. It does not matter what funds were actually used for what expenses. You are allowed to allocate the expenses as needed to claim the tax benefits. Think of scholarship money and 529 money and loans and personal money (bank & investment accounts) as just one pile of money. You're free to disburse (allocate) from the pile. That's the tax rules. It's legal and even encouraged by the IRS*.
Your qualified ed expenses (QEE) are $34,472 +7790 + 44 = $42306
$42,306 - 25,250 Scholarship = $17,056 Adjusted QEE
Your 529 plan distribution ($18,656) is more than your AQEE, So, a small portion is already taxable even if you don't claim the AOTC. But, you should claim the AOTC.
$17,056 -4000 (for the AOTC) = 13,056 Revised AQEE
$18,656 - 13,056 = $5600 non qualified distribution. 5600 / 18656 = 30.02% of the earnings are taxable. 0.3002 x 6308 = $1893 of taxable income gets reported on the student's return.
Reply back if you need instructions on how to enter. Making part of the scholarship taxable, might be an option, but I would need to know the exact amount of her wage income. $12,950 is the cut off point**.
*From the form 1040 instructions: “You may be able to increase an education credit if the student chooses to include all or part of a Pell grant or certain other scholarships or fellowships in income. For more information, see Pub. 970, the instructions for Form 1040 and IRS.gov/EdCredit". PUB 970 even has examples of how to do the “loop hole”.
**Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $12,950 filing requirement and the dependent standard deduction calculation (earned income + $400). It is not earned income for the kiddie tax and other purposes (EIC. IRA contributions )
