You cannot use the purchase of the car in any way shape or form as a qualified educational expense unless the terms of the scholarship specifically state that it can be used for transportation expenses- then you would shift the expense from tuition and apply the Coverdell- but if you do not have evidence to support this (because most scholarships do not), you cannot claim it as such.
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Thanks for the response, but I'm not talking about using a car as a qualified education expense. I fully realize I have to pay taxes on the distribution (unlike if I used it towards tuition), but I should NOT have to pay a 10% penalty per IRS Pub 970 (https://www.irs.gov/pub/irs-pdf/p970.pdf), pg. 54 where it says:
Generally, if you receive a taxable distribution, you also must pay a 10% additional tax on the amount included in income.
Exceptions. The 10% additional tax doesn't apply to the following distributions:
3. Included in income because the designated beneficiary received: a. A tax-free scholarship or fellowship grant (see Tax-Free Scholarships and Fellowship Grants in chapter 1);
Exception (3) applies only to the extent the distribution isn't more than the scholarship, allowance, or payment.
I received a full scholarship for tuition and room/board. The tuition portion was $21,549. I took a $15,900 Coverdell distribution. I don't think what I took it out for matters as I have to pay taxes on it, I get that. My distribution isn't more than the scholarship, therefore should I not have to pay the 10% penalty on top of taxes as per what Pub 970 says?
No. Coverdell IRAs are for qualified education expenses. If you want to claim the exception that the distribution was for tuition, then you should simultaneously report the scholarship portion that was received that exceeded qualified education expenses.
Please refer to page 5 of Pub 970 which states:
A scholarship or fellowship grant is tax free only to the extent:
• It doesn't exceed your qualified education expenses;
• It isn't designated or earmarked for other purposes (such as room and board), and doesn't require (by its terms) that it can't be used for qualified education expenses; and
• It doesn't represent payment for teaching, research, or other services required as a condition for receiving the scholarship.
For exceptions, see Payment for services, later. Use Worksheet 1-1 to figure the amount of a scholarship or fellowship grant you can exclude from gross income.