How to claim an American Opportunity Tax Credit by designating $4,000 of 529 fund withdrawals as taxable. 1098-T, 1099-Q, AOTC

[Haven2025]

Hello! Two years ago you helped me claim $4,000 as taxable 529 money in order to claim the full AOTC amount. I kept all the notes so if the same situation came up I could handle it. Well it’s still confusing! I struggle with navigating TurboTax Online and not being able to see the big picture as I move to each step. I would be so grateful for your help again.

Background details:

• College daughter is a full-time student and my dependent.
• 1099-Q, 1098-T, daughter is recipient
• Only one prior AOTC claim, I meet the income guidelines.

1099-Q

Box 1 $51,000 Gross Distribution

Box 2 $39,338.33 Earnings

Box 3 $11,661.67 Basis

1098-T

Box 1 $62,603 Payments received

Box 5 $31,200 Grants

Deductions & Credits section - I’ve indicated Yes to having received a 1099-Q (currently no detailed info is entered in TurboTax)

“Here’s Your Education Summary” section -

Tuition of $62,603

Bks & supplies $1,309

Grants $31,200

*Room & Board $19,679 (turbo tax referenced it but did not provide a place for me to enter it)

Currently TT shows my AOTC amount of $2,248 and a slightly lower than $500 for a Child Credit amount.

Based on info you sent me in the past, I’ve made the following calculation:

$82,200 in educational expenses (inc. R&B)

-$31,200 college grants

-$4,000 used to claim the AOTC

= $47,000 can be used against the 1099-Q

Box 1 of the 1099-Q - $51,000

Box 2 - $39,338

47,000/51,000 = 92.2% of earnings are tax free, 7.8% are taxable

0.078 x 39,338 = $3,068

This $3,068 is taxable income to report. As you mentioned last time, “None will be subject to the 10% non-qualified distribution penalty because the non-qualified portion of distribution was used to claim a credit”. Is this still the case?

Let me know if all that is correct. If so, then I’ll have to get everything entered correctly into Turbo Tax online.

1. I have yet to figure out how and where room and board gets entered… there was only a line for books & supplies.
2. Do not know where I enter the $4,000 as I have not found the screen titled “Amount Used to Calculate Education Deduction or Credit”
3. How do I find the area/form that shows line 8 of Schedule 1 to see if it shows $3,068? As well as the $1,000 refundable portion that should be on line 3 of Schedule 3.

1099-Q Comments:

I initially entered the 1099-Q in Turbo Tax, indicating my daughters name. In my search to find where I enter an amount of 529 money to be taxable, I’ve taken it out …then observed that took away the dependent child credit of $500 but the overall tax refund mysteriously went down to $413 and the overall tax refund increased by $444. Also, I think it was part of the process in entering 1099-Q info that I was asked to provide my daughter’s income for 2022 (taxable income is about $2,816). Some things after entered, seem to get hidden as I can’t find them if I go back to look.

Hoping you can help me out again this year!

[Hal_Al]

Q. This $3,068 is taxable income to report. As you mentioned last time, “None will be subject to the 10% non-qualified distribution penalty because the non-qualified portion of distribution was used to claim a credit”. Is this still the case?

A.  Yes and your numbers appear to be correct.

Before we get into the details of how to enter all that (and it will be complicated).  There's a better way, if the terms of  her scholarship are not restricted to paying tuition.  She can declare $4000 of her scholarship to be taxable income*. That allows you to use $4000 for the AOTC and all the other expenses to be fully used to cover the 529 distribution.  The 1099-Q doesn't have to be entered.  You save money and entry in TT goes easier.  

Q. How is having $4000 taxed better than having $3068 taxed?

A.  Taxable scholarship is considered earned income for purposes of calculating a dependent's standard deduction (earned income + $400 but not more than $12,950). Taxable 529 earnings is considered unearned/investment income. Her standard deduction is limited to $1150 and the income is subject to the "kiddie tax" (taxed at the parent's marginal rate).  In other words, if she has no other income (or about $2,816) the scholarship goes untaxed, but the 529 would be taxed. 

*From the form 1040 instructions: “You may be able to increase an education credit [or 529 plan exclusion] if the student chooses to include all or part of a Pell grant or certain other scholarships or fellowships in income. For more information, see Pub. 970, the instructions for Form 1040 and IRS.gov/EdCredit".  PUB 970 even has examples of how to do this “loop hole”.

I have not reviewed your "1099-Q Comments:" yet. 

[Hal_Al]

Re: "1099-Q comments"

I'm not following most of that. 

" took away the dependent child credit of $500" would mean you somehow declassified her from being your dependent.

Having other income ($2816) would push more of the taxable 529 earnings into the kiddie tax range. (I edited my original reply to account for the $2816). 

"Some things after entered, seem to get hidden as I can’t find them if I go back to look". It's TT flaw, not giving you a 2nd chance to enter some non common things.

[Haven2025]

Thanks for the reply!

The college grant is non taxable so the taxable income to claim AOTC will need to come from withdrawn 529 funds. I guess I’ll have to walk the complicated path. I’m hoping you will be able to help me navigate this on TurboTax.

Just to clarify, I’m working on my taxes as HOH with my daughter as a dependent.

As far as the “1099- Q comments”, I see it wasn’t written very clearly. At this point, I’ll make a note to make sure it is there after entering all the necessary AOTC information.

Thanks!

[Hal_Al]

"The college grant is non taxable"

That's not a valid, stand alone, statement.  The scholarship may be non taxable, if it was used for qualified expenses.  You don't have to use (actually only allocate) it to tuition, unless the scholarship is "restricted".  That is, the conditions of the grant say it can only be used for tuition.

Being HoH doesn't change anything (kiddie tax rate will kick in later). 

[Haven2025]

Ok, I see what you are saying. I called the college to get more clarification and they only could state “all scholarships/grants go to education expenses”.  This appears to mean it is not restricted to paying tuition, thus an option to claim an AOTC credit.

Although, in looking at your response outlining the scholarship option vs 529 option, it looks like you referenced $2,816 in total income for my daughter’s 2022 personal taxes. She has W-2 income of $15,604 and 1099-DIV of $163. Total Income of $15,766, resulting in $2,816 above the standard deduction of $12,950.

With this added detail, does the scholarship option go away?

Also, I’m not sure what you mean by “kiddie tax”.

[AmyC]

From your message:

“Here’s Your Education Summary” section -

Tuition of $62,603

Bks & supplies $1,309

Grants $31,200

Room & Board $19,679

Recalculating to avoid the 1099-Q

$82,200 in educational expenses (inc. R&B)

-$51,000 1099-Q

-$4,000 used to claim the AOTC

= $27,200 can be used against the grants

$31,200 college grants

-$27,200 left over

=$4,000 taxable scholarship  which may no longer be a good idea. Just a reminder about scholarships, they are unearned income and can affect the kiddie tax. She will need to add form 8615. See How do I report and pay the Kiddie Tax on my return this year?

You will need to juggle both returns and the tax situation to determine IF the AOTC will work for you this year. Since your daughter is filing a tax return, the kiddie tax will kick in.

See 

• Topic No. 553 Tax on a Child's Investment and Other Unearned Income (Kiddie Tax)
• About Form 8615, Tax for Certain Children Who Have Investment Income

[Hal_Al]

Q. With this added detail  (W-2 income of $15,604), does the scholarship option go away?

A. Yes

[Haven2025]

Hello!Thank you for adding to this thread. It appears my best option is to claim $4000 of 529 money as Taxable.

A few questions…

1. Where do I enter R&B? There is no place for it in the “Here’s Your Education Summary” section.
2. Where do I indicate $4000 of 529 money to be taxable for the AOTC claim? Or has TT already figured this out?? TT tells me I am receiving AOTC claim of $2,248, not sure why it isn’t the full $2,500
3. Am I able to confirm this was all entered correctly and shows my AOTC credit as well as my medical premium credit based on my 1095-A, etc
4. Does claiming AOTC money affect the Child Credit of $500? This currently is showing $0 on TT. I do have her listed as a dependent, she is 23 years old and a full time student.  Seems like I should be getting the full $500

Misc Comment:

- I’m not planning to enter 1099-Q information as I understand it is not needed even though I’ve been prompted a couple times as I go through steps in TT. I did answer the questions indicating that I received this form and who the student is.  

[Hal_Al]

Q1. Where do I enter R&B? There is no place for it in the “Here’s Your Education Summary” section.

A. 1. To get the screen to enter Room & Board, answer yes when asked if you have book expenses. On her return, be sure you enter the 1099-Q first so that TT knows she needs to enter R&B. 

Q2. Where do I indicate $4000 of 529 money to be taxable for the AOTC claim?

A2.  TT will assume $4000 for the AOTC.  You may have to verify that on the student information worksheet (part VI, line 17)

Q3 Or has TT already figured this out?? TT tells me I am receiving AOTC claim of $2,248.

A3. Yes, If TT calculated that, it has already assign $4000 tuition to AOTC.

Q4. TT tells me I am receiving AOTC claim of $2,248, not sure why it isn’t the full $2,500.

A4.  What's on line 15 of form 1040? It sounds like you don't have enough tax liability to get the full credit (only 40% of the calculated amount is refundable).

Q5. Am I able to confirm this was all entered correctly and shows my AOTC credit as well as my medical premium credit based on my 1095-A, etc

A5. For details look at the student info worksheet and form 8863.  I'm not familiar with the medical premium. But since it's refundable, I would think it's not affected.

Q6.  Does claiming AOTC money affect the Child Credit of $500? This currently is showing $0 on TT. I do have her listed as a dependent, she is 23 years old and a full time student.  Seems like I should be getting the full $500

A6. Yes, same as the reduced AOTC. The $500 Other dependent Credit is non refundable.  If your tax liability is already reduced to 0 by other credits, you may not get  it (or all of it). 

Q7. I’m not planning to enter 1099-Q information, on my return,  as I understand it is not needed even though I’ve been prompted a couple times as I go through steps in TT. I did answer the questions indicating that I received this form and who the student is.  

A7. Yes, you don't have to enter it on your return.  But you can.  if you answered that you received it, you should indicate that she is the recipient. TT will calculate the taxable amount and tell you the recipient-beneficiary should report it. Since you daughter is the recipient of the 1099-Q, she enters it on her return.  The taxable portion goes on her return.  (which you know should be $3068). The interview and calculation are actually smoother in your interview than in hers. 

[Haven2025]

Thanks for replying once again. Preparing my taxes has been so very challenging to me this year. I have a few follow-up questions and some additional information.

Regarding where to input Room & Board:

There is no prompt in “Here’s Your Education Summary” for room & board. When I select edit to “Other Education Expenses” it asks, “Did Marie Pay for Books or Materials to attend school?” There’s is then a line referring to deductions of books/supplies and it also references room and board. I check the Yes box. Then scroll down to “Enter Marie’s Education Expenses”. The only three options to enter expenses are Tuition (this is populated already), books required from school and books not required.

I have now entered the 1099-Q info and TT indicates the student beneficiary must report $21,821 of taxable income. No doubt this is because of the missing R&B.

My income sources are Interest, Dividends, Long-term Capital Gains (49% of Line 9)& IRA Distribution (Roth conversion)

Federal 1040 worksheet shows:

Line 9 $75,821

Line 11 $71,171

Line 15 $51,771

Tax Smart Worksheet Line I $1,248

Line 29 $1,000

Line 31 $1,276

TT states I qualify for AOTC $2,248. I now think my taxes owed are too low to accommodate a full credit on this as well as the child tax credit. I didn’t do so well on my attempt to manage my income level to allow for qualification on credits yet maintain a tax level to receive the credits. 

TT shows my refund to be my total estimated taxes paid-in for 2022 plus $2,276. It appears to be a total of my Premium Tax Credit of $1,276 and $1,000 AOTC refund.

I’m assuming due to some of the non-refundable rules, I do not see my credit claims to be full amounts.

Child Credit $500

AOTC $2500

Premium Tax Credit - $1,276 - $1,505 (depends household income)

Form 1095-A self-insurance

Q. Should my daughter file as a dependent and claim AOTC?  This daughter has a twin that has been a dependent on her dad‘s taxes until last year when she filed as a “single” and claimed the AOTC credit. Her college finances mirror the daughter that is my dependent and her return was prepared by an accounting firm. My daughter will have taxable income after deductions of about $2,700. 

Do you have a sense if the better global benefit is to allow my daughter to claim AOTC and get a full amount versus me no longer being HoH and only claiming the Premium Tax Credit? 

[Hal_Al]

"My daughter will have taxable income after deductions of about $2,700". 

Is that the amount on line 15 of form 1040?  Does that include the $3068 taxable portion of the 1099-Q? 

Q. Do you have a sense if the better global benefit is to allow my daughter to claim AOTC and get a full amount versus me no longer being HoH and only claiming the Premium Tax Credit? 

A. No. Her tax liability (which will be the amount of AOC she gets) is much less than the close to $2500 AOTC you will get.  Even if she did qualify as a dependent, your AOTC is still larger). 

If your daughters are under 24 and full time students they are not eligible for the  refundable AOTC, unless more than 50% of their support comes from her earned income.  If they have a tax liability they can claim the AOTC as a nonrefundable credit, but then the parent has to forego the $500 dependent credit. 

Reference: Line 7 instructions for form 8863. https://www.irs.gov/instructions/i8863

When I did a test (desktop Deluxe) I got the R&B entry screen (in both the parent and student returns).  Since you have calculated the taxable amount, manually, there is a work around for entering it, but you won't get any supporting work sheets.