The system is "looking" for the qualified educational expenses incurred that would equal the distributions received. You say you are CA, savings plan is CO, but I am not sure what PA has to do with anything unless that is where the school is at, possibly? I am just trying to understand with your multi-state situation where PA fits in is all. Having said that, if you've withdrawn funds from a 529 plan and did not use the money towards qualified education expenses, then you will be taxed on these moneys that you withdrew.
The AOTC offers a 100% credit for the first $2,000 used to pay for education expenses and 25% for the next $2,000 used, for a maximum credit of $2,500 if you spend $4,000 on qualified expenses.
Money in a 529 plan can only be withdrawn tax-free when used for qualified expenses that were not covered by payments that generated the AOTC. So, in this scenario, the taxpayer would subtract $4,000 from the qualified educational expenses they paid when determining how much they should withdraw from their 529 plan.
State-level income tax benefits can vary. Some states don’t offer any perks for using a 529 plan, while others will let you deduct a portion of your contributions from your state taxable income. For example, Massachusetts lets you deduct up to $1,000 in 529 plan contributions ($2,000 if married, filing jointly) from your state taxable income.
Also, keep in mind that you can use another state’s 529 plan if your state doesn’t offer a tax benefit, or if another state’s 529 plan offers lower fees or better investment returns. It’s important to do your homework and research all of your options first. To learn more about each state’s 529 plan tax benefits.
