My previous analysis (that it would be pretty much a wash with or without the AOTC) was assuming that we could push 100% of the excess distribution (ie, both from his 1099-Q and ours) to his return. Thanks to your explanation I now realize I can't do that. So the scenario I asked about in my last post involved pushing as much of the taxable income as possible to his return by allocating all of the qualified expenses to ours. But that would produce for him about $4900 of unearned income (plus another $25 of interest earnings from his bank account) against only $2800 in earned income. (He has no other sources of income, scholarship or otherwise.)
I've never dealt with the kiddie tax but have now researched it a bit. My gut tells me I would like to avoid that complication if possible, perhaps even if it costs us some money.* But maybe it's not that bad. It looks like the kiddie tax only applies if he is required to file a return. The Interactive Tax Assistant on the IRS website tells me, after I answered a bunch of its questions, that assuming we use the first $4900 of 1098-T expenses to wipe out his share of the excess distribution he is not required to file a return. If he did file a return in this scenario he would have no liability (his bank interest is less than $450) but he would get no refund because no federal income tax was withheld from his wages (although state and local taxes were). Of course, if we go this route, we maximize the amount of excess distributions taxed on our return at a higher marginal rate.
On the other hand, it looks like if we get his total unearned income to $2600 or less (by allocating some of the excess distributions to his return) we avoid the kiddie tax - is this correct? In that case, he would file a return, monetize the entire standard deduction (ie, the remaining $425), and we'd maximize the amount of excess distribution taxed at his lower marginal tax rate without triggering the kiddie tax. Do I have this right?
Finally, if we do find ourselves in kiddie tax land: we maximize the excess distribution taxed at his lower rate but expose a bunch of his earned income to tax because his standard deduction drops to $1300. Further, I have to get acquainted with Form 8615 and await whatever other surprises it has in store for me. Do I also have this right?
And each of the three scenarios above could be further complicated by whether he claims the AOTC.
Thanks again for the guidance.
*I'm kinda past the point of trying to optimize my tax savings to the last dollar. I just want to get in the ballpark, making sure I have a compliant return and not leaving a bunch of money on the table. This is now my 7th tax year of dealing with education expenses and I'm clearly still wrestling with how to properly manage the transactions and calculate my liability correctly; you're right - it is complicated. I'm questioning whether the financial benefits we've realized are worth the time I've spent over the years.
