On your tax return, enter the 1098-T and claim the AOTC. Do not enter your 1099-Q We will allocate $1050 of expenses to make it not reportable.
Accounting (check my math):
(T1) 39,390 - (T5) 26,500 = $12,890 Tuition available for the 1099-Qs and AOTC
$12,890 + 13,030 = $25,920 total available qualified educational expenses (QEE).
$25,920 - $4000 (used for the AOTC) - 1050 (allocated to your 1099-Q) = $20,870 QEE for her 1099-Q
That is less than the box 1 amount (24,139) on her 1099-Q. So, some of it is taxable.
24,139 - 20,870 = $3269 of the distribution is non qualified.
3269 / 24,139 = 13.54% of distribution is non qualified.
(box 2 earnings) $9731 x 13.54% = $1318 of taxable income on her return. It goes on line 8z of schedule 1. TT will prepare form 5329 to claim the penalty exception (for the AOTC allocation). The $1318 is barely over the $1250 filing requirement If that is her only income, you're only looking at about $7 of income tax.
How to enter that in TurboTax (TT)? "Proper" way: Enter the 1099-Q first. Later, enter the 1098-T and the books and room & board expenses. You must answer yes to the book expenses question to get the R&B screen. You will eventually encounter a screen "amount used to claim education credit" (or some such wording). Verify that TT is using $4000 or change it to $4000. Verify the outcome( $1318 on line 8z of schedule 1. Warning: it gets complicated and mistakes can be made.
Workaround short cut: Enter the 1099-Q. When asked who the student is answer: someone else not listed here (lying to TurboTax to get it to do what you want does not constitute lying to the IRS). Enter the student's name when asked. A few screens later, you'll get one simple screen to enter expenses ($12,890 tuition and $11,980 R&B [13,030-1050]). Press Done at the 1099-Q summary screen, to get there. Also enter $4000 in the box "Tax-free assistance". This reports the earnings as taxable and claims the AOTC penalty exception. You do not have to deal with the complicated “Educational expenses and Scholarships” (1098-T) section later.
You can use this method whether entering a 1099-Q on your return or the student's return.
