Q. Is the $6000 basis portion of the 529 distribution non-taxable because it is not earnings?
A. Yes, but it is not "deducted off the top". The taxable portion of the earnings is determined by a ratio of the non qualified portion of the distribution, if any, to the total distribution.
Q. Can he take the American Opportunity Tax Credit (AOTC)?
A. Yes, but the qualified portion of the 529 distribution will be reduced by the amount of expenses (most likely $4000) used to claim the AOTC, making part of the distribution (w/d) taxable on your return.
Q. I am thinking because the $6k Basis portion of the 529 withdrawal is greater than his $4k AOTC limit, his AOTC eligibility should not be hindered by the 529 w/d on my return? (Since there is no "double dipping", correct?
A. No. The simple explanation is: it doesn't work that way. See the math below. There is double dipping. But, you two get to decide how to allocate the expenses between you for the best outcome (him using $4000 for the AOTC is almost always the best way to go).
$13,000* in educational expenses (including room & board).
-$4000 used to claim the American Opportunity credit on student's return
=$9000 expenses Can be used against the 1099-Q (on your return)
Box 1 of the 1099-Q is $13,000
Box 2 (earnings) is $7000
9000/13000=69.23% of the distribution is qualified, so 30.77% is non qualified. This means 30.77% of the earnings are taxable
30.77% x 7000= $2154. There is $2154 of taxable income on your (the recipient of the distribution) return.
Multiply that by your marginal tax rate (e.g. 12% x 2154 = $258 in tax) to compare to the $2500 AOTC your son (probably) gets.
* It wasn't clear whether your total expenses are $13,000 or $18,000. You taxable income will be a little more with an $18K distribution.
