I am a bit confused as to how Turbotax is calculating taxable income on an early withdrawal from a 529. Using the below example, if I had a $100,000 distribution and $50,000 of the distribution was earnings, and had $25,000 of education expenses, why is Turbotax allocating the education expenses against the total distribution and giving taxable income of $37,500?
It was my understanding that there would be a 10% early withdrawal penalty on $75,000 (distribution minus education expense) and then the expenses would go dollar for dollar against income (earnings minus education expense) giving $25,000 taxable income in the example above.
Since the $100,000 distribution was contributed originally post-tax, this does not make sense that some of that income would be taxed again given how Turbotax is calculating.
Can someone please explain to me?
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25,000 of expenses divided by $100,000 distribution =25% of the earnings are tax free and 75% are taxable (and subject to the penalty. 0.75 x 50,000 = $37,500
TurboTax will usually assume that some (usually $10,000) of the expenses were used to claim an education credit. That leaves $15,000 of expenses to be used against the 529 withdrawal shown on the 1099-Q.
15,000 / 100,000 = 15% of the earnings are tax free. 0.15 x 50,000 = $7500. $42,500 (50,000-7500) would be taxable. But only $32,500 would be subject to the penalty (using the money to claim a tuition credit is a penalty exception)
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