I believe that I have identified a limitation in the way TurboTax calculates qualified education expenses for the American Opportunity Tax Credit (and probably the Lifetime Learning Credit as well) when prepaid tuition 529 plan funds are used:
TurboTax (Deluxe) apparently does not consider distributions from prepaid tuition 529 plans as amounts that can't be used in Adjusted Qualified Education Expenses. In fact, tax-free distributions from prepaid tuition 529 plans can only be used to pay for tuition and fees (whereas distributions from general 529 plans may also be used to pay for room and board, and school supplies.) This limitation incorrectly allows filers to claim more AOTC credit than they may be entitled to.
In my situation, only $1,634 of expenses were eligible to be used to qualify for the AOTC; however, TurboTax calculated that I could claim up to the maximum credit (based on more than $4,000 of "allowed" expenses.) I compensated for this limitation by itemizing entries on the Tax-Free Assistance line in the Student Info Worksheet form, and including as one item the amount of the prepaid tuition 529 plan distribution that should have been disallowed.
I suggest that TurboTax be modified to distinguish between general 529 plans and prepaid tuition 529 plans, and to correctly calculate the allowable AOTC due to each.
