Excess distribution from 529 for loan payment < $10,000 (which should be qualified)

[VAtaxpayer6]

TurboTax Deluxe 2020 is calculating 529 plan excess distributions that exactly equal a student loan payment of less than $10,000 that I made with 529 funds.  According to the Secure Act of 2019, student loan payments of less than $10,000 should be qualified education expenses. I haven't paid other student loans, so I have not exceeded the $10,000 limit. The excess distributions are applied to multiple 1099Qs and then I'm taxed and penalized 10%. The loan payment is reflected in Part VIII of the Student Info Worksheet, so I don't understand why is is not applied as a qualified higher education expense. Perhaps I did something in the wrong order? I'm wondering if I should delete the 1099Q for this expense or delete all forms for this student and start over. Any suggestions? Thank you!

[ThomasM125]

You should have seen this screen after you entered your form 1099-Q where you can indicate that you used the proceeds for student loan payments:

Once you enter the amount of your student loans paid with the 529 plan distribution, the  earnings on the distribution amount should not show as taxable on your tax return.

[VAtaxpayer6]

@ThomasM125 Thanks for trying to help! I deleted my 1099Qs and re-entered them. I did see the screen you copied, where I entered $8,000 principal paid and zero interest paid (none had accrued) on qualified education loans. I had done this before, too, as the amount paid was still present when I got to that screen. Unfortunately, TurboTax is still calculating excess distributions of $8,000, adding an amount as Other Income to Schedule 1 as "Qual State Tuition Prgm from 1099-Q," and to my 1040, and calculating additional tax on that amount. I know I did not take other excess distributions, and have checked the amounts entered on the Student Info Worksheet. Oddly though, the Student Info Worksheet section Part VIII shows $0 in "Earnings taxable to recipient" on line 8, and all qualified expenses are reflected correctly. 

[VAtaxpayer6]

Since there seems to be a bug in calculation of excess 529 distributions, I'm wondering if a workaround would be to delete all of the education forms for this student. Our distributions were all qualified expenses and we did not take excess distributions. The amount of distributions exactly equaled amounts paid for tuition, allowable room and board, and the $8,000 student loan payoff. This student graduated in 2020 and we are not trying to qualify for the AOC or LLC.  If I can delete all related forms to stop calculation of additional income on excess distributions that don't really exist, that might be easiest.

Any advice on which forms to delete?

1099-Q, 1098-T, and the Student Info Worksheet?

Schedule 1 which shows additional income from qualified tuition plan?

Other Income (which regenerates if deleted)

5329 (which regenerates if deleted)

Thank you in advance to any experts who can advise me!

[AmyC · Accepted solution]

Delete it all! Once the 1099-Q is deleted, the 5329 will quit showing up. 

I would recommend that you keep your list and paperwork all together. The IRS may come back in 3-4 years and say you had 1099-Q income. You want to be able to make a copy of your records and send it back with their letter. Even if you reported the 1099-Q, they could still ask for the expenses so it is moot.

[VAtaxpayer6]

Thank you for your reply, AmyC. I was not keen on removing all student information, so I tried these steps in Forms View and they worked: 1) First I went into the Student Information worksheet and deleted the Y/N section about paying a student loan and deleted the amount of the loan payment near the bottom. 2) Then I deleted the 1099Q for the loan payment. 3) There was a form that indicated it was "not done" - I think it was the Tuition Summary. I re-launched the optimizer (I have another college student), and the red not done indicator disappeared. 

After those steps, the 5239 and Schedule 2 went away, and my return no longer reflects additional income for excess distributions. So I am now in good shape (yay!) and I keep good records. I do believe there is a flaw in how TT is accounting for the SECURE Act of 2019 provision that up to $10,000 in lifetime student loan payments are now considered qualified higher education expenses. 

[AmyC]

I tried out the student loan and the 529 on my desktop version and didn't have a problem but it could be the factors I used or how I entered it. There is always room for improvement, wording, tips, something!

I am so glad you got it to work out. That was smart thinking and sounds great. The goal is for the tax forms to be correct.

Great job!

[JonMLevine]

I'm having this issue with TurboTax 2021, too. I had to override the calculation worksheets toward the bottom of the 1099-q forms in TurboTax.

Why doesn't Turbotax fix this?

[JonMLevine]

This did not work for me. I followed these directions but the amount still kept showing up as taxable.

[MarilynG1]

You don't have to report the 1099-Q in your return if the entire distribution was used for Qualified Education Expenses (including student loan payments).

Click this link for more info on Form 1099-Q.

Here's more discussion on Paying Student Loans with 529 Distributions.

[JonMLevine]

I suppose I can work around it by not entering the 1099-q at all, but that seems to make Turbotax less useful. Will the Turbotax accuracy guarantee still apply if I omit a form?

[KrisD15]

No, the guarantee is only for information/forms entered. 

Please review the entry of the 1099-Q

On the "Who's the student?" screen, be sure to select the person that was issued the 1099-Q

DO NOT SELECT "THIS DISTRIBUTION WAS NOT USED TO PAY ANY EDUCATION EXPENSES" 

Student loans are accepted as "education expenses" for 1099-Q distributions for tax year 2021. 

Continue through to the "Form 1099-Q Summary" screen and click Done

 ON THE NEXT SCREEN click None of the above and continue

The following screen will ask about student loans. 

If the distribution was used for loan payments, that amount would be entered here making the distribution free from tax. 

You may also claim the interest on the loan as a "Student Loan Interest" deduction however, claiming it as a separate deduction may or may not impact the taxability of the distribution reported by the 1099-Q. 

[JonMLevine]

Thanks, but I've tried this. It doesn't work properly. The amount of the student loan payment shows up correctly on the "Student Information Worksheet", but it never flows through to the 1099-Q worksheets -- the amount for loan payments on those worksheets is always 0.

[momtaxy]

Jon, I had the same problem where the student worksheet didn't match the form 1099-Q worksheet regarding a loan payment. I remember seeing (I believe the FIRST time I entered the 1099-Q information) a question at the very bottom that asked if some of the distribution was used to pay on a student loan.  You were to click yes or no.  I clicked no, in error, and have been unable to "reproduce" the question in order to answer it correctly.  I think the page of the interview that asks about loan payments (where you enter the principal and interest paid) has no effect on the form 1099-Q worksheet.  I did as someone else suggested and right clicked in the loan entry space on the form 1099-Q worksheet (line 2a of both columns) and selected "override" in order to manually enter the loan payment amount...the value shows in red, but it seems to have worked!  It took the tax away that it previously said we owed.  Deleting and re-entering the 1099-Q didn't help.  We don't qualify for either education credit.

[baxterjames96]

Thanks for everyone (not at Turbo Tax) for providing info on how to correct this.  Amazing that Turbo Tax has allowed this bug to sit around for two years now.  If I hadn't been paying attention this would have cost me in excess of $2,500!