You may already know this, but some of your 529 distribution will be taxable. You don't have enough Qualified educational expenses (QEE) for the 529 distribution to be tax free.
$25,994 Total QEE
- 500 Paid by scholarship
-4,000 Used to claim the AOTC
=21,494 Available for the 1099-Q
22,539 - 21,494 = $1045 of the distribution is non qualified
1045 / 22,539 = 4.63% of the distribution is non qualified
$1617 (box 2 earnings) x 4.63% = $75 taxable income. The 10% penalty will not apply because you used some of the QEE to claim the AOTC ("The tuition credit exception"; there is also a scholarship exception).
If you have some book and computer expenses, that amount can probably be reduced.
There are three things you can do with your Qualified educational expenses (QEE):
- Allocate then to scholarships (so that the scholarship remains tax free)
- Use them to claim an education credit
- Allocate them to the 529 distribution (1099-Q) so that it will not all be taxable
TurboTax allocates QEE, in that order, but it doesn't always do a very good job if you want something different. TurboTax allocates QEE, in that order, until you tell it otherwise. It's best if you have some idea of the outcome expected, when you make your entries. You are allowed to re- allocate the QEE for the best tax outcome. Note that it does not matter what you actually paid "out-of-pocket".
