North Carolina 529 and Education Credit

[puggyman92]

I'm really hoping someone can help me here.   I went through Turbo Tax , section on Education Credits, and it said I was eligible for the $2500 American Opportunity Education credit.  

I happened to mention this to a couple of other people who asked if I paid tuition from a 529 plan ...which I did.  They said I couldn't claim the credit since this was the case.  

I started doing research and it seems like there is a lot of confusion about this.  I've spoken to several Turbo Tax experts and I can't get a straight answer either. 

My situation:

Tuition paid from NC 529 and listed on my son's 1098-T:   $13, 455

Scholarship on 1098-T: $250

Gross distribution on box 1 of the 1099-Q (in my son's name) : $13, 164

Earnings listed on box 2 of the 1099-Q : $4,501

Basis listed on the 1099-Q: $8,663

I've seen some articles that discuss similar scenarios, but there seems to be confusion as to whether , as a parent, I'm eligible to claim the credit because I paid all the tuition from the NC 529.  Some folks are saying I should've paid some portion of the tuition "out-of-pocket".  Even if I am eligible, how much can I claim?. I'm also baffled as to why Turbo Tax didn't catch this and ask for further details.  There was a question about whether we used a 529 for an education loan.  The answer is no because he didn't have a loan.  

North Carolina does not offer a tax break for 529 contributions, but does offer tax-free gains when used for qualified college expense.  I've seen the calculations (including the IRS site) about possibly determining additional taxable income amounts when claiming the credit, but even if I go by those, I can't figure out where to list in Turbo Tax.  I'm also not sure if that should be listed on my return or my son's return, since the 1098-T and 1099-Q are in his name. 

Any insight would be greatly appreciated.

Thank you

[AmyC]

It's complex and the IRS does recommend you use a loophole they left open on purpose.  Our goal is $4,000 that you paid for out of pocket.

Let's start with the Q.

1. It can be used for room and board,  along with education expenses. Determine the room and board (on or off campus using the school's information-even at home) for your student.
2. $13,164 minus room and board = money left for education
3. Locate other educational expenses - books and supplies and other items required to be purchased.
4. Line 2 minus line 3 = remainder to go against tuition.

Check the 1098-T

1. $13,455 paid 
2. We don't really care about the scholarship money right now unless it was marked that it had to go towards educational costs and was not allowed for room and board. If it was not designated, it can be income to the student. $250 income there won't hurt but it can help you with getting more credit. Is it designated or not?
3. Line 1 or line 1 minus line 2 for designated scholarship to education

Final result:  1098-T total - Q tuition amount. Hopefully, you were able to spend more of the Q outside tuition and hopefully the scholarship wasn't designated.

Whoever claims the student, claims the credit. Often, the student doesn't have enough income to help. If your student is full time and under 24, you probably can claim them but best to be sure. Take this quick quiz, Dependent to determine what is correct.

You don't need to enter the Q since it was fully used. Since the 1099-Q was not income, it should not be entered. Tuck the 1099-Q into your tax folder. IRS Publication 970, Tax Benefits for Education states that nontaxable distributions should not be entered. Keep your school expenses, room and board, and how you figured things out with your records.

One of you, based on the quiz above,  would enter the 1098-T and reduce the educational expenses by the amount covered by the Q for tuition. If it is $4,000 or more, full credit. If less, still a credit.

[puggyman92]

Thank you.  I'm definitely claiming him as a dependent.  I realize the 529 can be used for room and board.  But room and board cannot be counted toward the AOTC.  Only tuition and books and materials according to IRS publications.  

I don't really have much out of pocket expenses.  Maybe a little for books.  But for simplicity I'm just looking at the tuition when related to the credit...which again was all paid with NC 529. 

I'm looking at Publication 970, page 52, which discusses the 529 (QTP) in relation to the AOTC.   I've included this small section below for convenience.  

I'm thinking based on their example.  I would use $4000 of the tuition paid by the 529 to use for me to get the credit.  Then on my son's return , I would add income based on the taxable portion based on growth earnings. .....I think :). 

I'm looking for validation here :)....but maybe I'm missing something.  

Thank you.

From Pub 970 , page 52

Coordination With American Opportunity and Lifetime Learning Credits
An American opportunity or lifetime learning credit (education credit) can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses aren’t used for both benefits. This means that after the beneficiary reduces qualified education expenses by tax-free educational assistance, the beneficiary must further reduce them by the expenses taken into account in determining the credit.
Example 2. Assume the same facts as in Example 1, except that the parents claimed an American opportunity
credit of $2,500 (based on $4,000 expenses).

Total qualified education expenses ......... $8,300
Minus: Tax-free educational assistance ...... − 3,100
Minus: Expenses taken into account in figuring American opportunity credit .............. − 4,000
Equals: AQEE ........................ $1,200

The taxable part of the distribution is figured as follows.
1. $950 (earnings) × $1,200 AQEE/$5,300 distribution
= $215 (tax-free earnings)

2. $950 (earnings) − $215 (tax-free earnings)
= $735 (taxable earnings)

The student must include $735 in income (Schedule 1 (Form 1040), line 8z). This represents distributed earnings not used for AQEE.

[AmyC]

Yes! Great job! The IRS very much encourages parents to claim the AOTC and shift the income to the student in a lower tax bracket, if any. The scholarship income is a hybrid income that counts as unearned income in terms of the Kiddie Tax. 

Reference: What is the Kiddie Tax?