American Opportunity Tax Credit AOTC and 529

[Hal_Al · Accepted solution]

"we have no room and board".

Not exactly true.  Everybody's gotta eat and sleep.  You may count room and board, when living off campus, even if living at home.  Board is more straight forward, than room.  But for students residing in  off-campus housing, qualified room and board costs must be less than or equal to what is included in the college's cost of attendance (COA) allowance for room and board for the period.  

Reference: https://www.savingforcollege.com/article/using-your-529-plan-to-pay-for-room-and-board

You only need to come up with $3590 of expenses to avoid tax on the 529 distribution.  Board and books, and computer and software and internet should do it..

TurboTax can (theoretically) handle all this, but it's tricky.  It's best to use a work around.  Lying to TurboTax to get it to do what you want does not constitute lying to the IRS. 

You have two simple workarounds.  On your return, enter only the 1098-T and claim the AOTC.  Do not enter the 1099-Q on anybody's return.

You can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip!  When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.

On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 

One user has reported receiving a CP2000 letter, from the IRS,  on 529 distributions, demanding tax.  He replied that his child was in college and the distributions were for qualified expenses, which he listed, but he did not provide receipts.. He  later received a notice saying he was in the clear.

I also received a CP2000 letter, from the IRS,  on 529 distributions.  i provider them copies of the school's billing statements. I also  received an all clear notice.

[jlar]

@Hal_Al   Thanks for the additional information.

I just realized that though this distribution was made via '529CollegeAdvantage', it's actually a 'prepaid tuition' program.  I'll have to check with the state on specifics but there seem to be some limitations on use of 'true prepaid' programs.  Those limitations may include use on tuition only (not books or room/board). Sorry for any confusion there (i bought this fund 19 years ago and never looked at it since).

Nevertheless, I need a 'simple' solution to my problem and I think I may have found it!

I verified the 'Taxable Portion of Distribution' first mentioned by @NCperson as $2184. Unless my plan allows things other than 'tuition credits' this is the number I'll use on my daughters return as the 'Taxable portion of the 1099-Q Distribution" (so as to avoid the 'double dipping').

After much trial and error (like, 7 hrs straight), I finally backed tracked through all the forms to realize there is a section on the 1099Q (in TurboTax 2019 form mode) that allows for just such inputs!

Here is what I changed:

1099Q - "Qualified Tuition Program (QTP) Computation of Taxable Distribution" section:

1) Changed line 2c (column 1) from 0 to 4000  *This arrives at a line 7 amount of $2184 as previously calculated

2) Changed line 2c (column 2) from 0 to 7590  *This results in a zero for the 10% taxable column

Unfortunately, change #2 alone did not eliminate the 10% penalty and form 5329-T was still showing a calculated 10% penalty on the new $2184 number. Trying to change form 5329-T, Part II, Line 6 to zero out the penalty results in 'errors' when you run the checker.

The final section of the 1099Q form has a section called "Distributions not subject to 10% tax".  Just what I was looking for! Line 1 showed the $2184 and there are several line 2 options to supposedly adjust that down. Clicking in those cells to enter an 'override' pops up another worksheet where you can enter descriptions and an amount. However, the entries do not persist in the form after you close the popup window (IS THIS A BUG IN TURBOTAX?)

What I find MOST interesting in ALL of this...is that line 2e is titled  "Included only because qualified expenses were taken in determining American Opportunity or lifetime learning credit".Or, per the 'help' button on that popup screen: ""The amount of taxable earnings allocable to income as a result of taking the American opportunity or lifetime learning credit".

So this is how you apparently claim the 'exception' for the 10% penalty???

Too bad that Form Mode field doesn't seem to work (ie Won't take a value in Form Mode). Nor does 'overriding' the total field for those lines make the penalty go away.

So, I changed line 1 in that section,"Distributions included in income", from 2184 to zero and that resulted in the penalty going away (and zero'ing out all fields in form 5239-T, which I then deleted). This still is probably not entirely correct but it arrives at what I think is the correct outcome  - she pays 'income tax' on the excess distribution of $2184 but doesn't have to pay a penalty on distribution because the excess was caused be me taking the AOTC credit on my return.

If anyone has any clue how to make an entry stick in line 2e of the above noted section please post it here. Or if this is confirmation of a BUG/DEFECT...maybe someone knows how to report that to Intuit?

Getting closer....thanks all!

[jlar]

'@Hal_Al   Thanks for the additional information.

I just realized that though this distribution was made via '529CollegeAdvantage', it's actually a 'prepaid tuition' program.  I'll have to check with the state on specifics but there seem to be some limitations on use of 'true prepaid' programs.  Those limitations may include use on tuition only (not books or room/board). Sorry for any confusion there (i bought this fund 19 years ago and never looked at it since).

Nevertheless, I need a 'simple' solution to my problem and I think I may have found it!

I verified the 'Taxable Portion of Distribution' first mentioned by @NCperson as $2184. Unless my plan allows things other than 'tuition credits' this is the number I'll use on my daughters return as the 'Taxable portion of the 1099-Q Distribution" (so as to avoid the 'double dipping').

After much trial and error (like, 7 hrs straight), I finally backed tracked through all the forms to realize there is a section on the 1099Q (in TurboTax 2019 form mode) that allows for just such inputs!

Here is what I changed:

1099Q - "Qualified Tuition Program (QTP) Computation of Taxable Distribution" section:

1) Changed line 2c (column 1) from 0 to 4000  *This arrives at a line 7 amount of $2184 as previously calculated

2) Changed line 2c (column 2) from 0 to 7590  *This results in a zero for the 10% taxable column

Unfortunately, change #2 alone did not eliminate the 10% penalty and form 5329-T was still showing a calculated 10% penalty on the new $2184 number. Trying to change form 5329-T, Part II, Line 6 to zero out the penalty results in 'errors' when you run the checker.

The final section of the 1099Q form has a section called "Distributions not subject to 10% tax".  Just what I was looking for! Line 1 showed the $2184 and there are several line 2 options to supposedly adjust that down. Clicking in those cells to enter an 'override' pops up another worksheet where you can enter descriptions and an amount. However, the entries do not persist in the form after you close the popup window (IS THIS A BUG IN TURBOTAX?)

What I find MOST interesting in ALL of this...is that line 2e is titled  "Included only because qualified expenses were taken in determining American Opportunity or lifetime learning credit".Or, per the 'help' button on that popup screen: ""The amount of taxable earnings allocable to income as a result of taking the American opportunity or lifetime learning credit".

So this is how you apparently claim the 'exception' for the 10% penalty???

Too bad that Form Mode field doesn't seem to work (ie Won't take a value in Form Mode). Nor does 'overriding' the total field for those lines make the penalty go away.

So, I changed line 1 in that section,"Distributions included in income", from 2184 to zero and that resulted in the penalty going away (and zero'ing out all fields in form 5239-T, which I then deleted). This still is probably not entirely correct but it arrives at what I think is the correct outcome  - she pays 'income tax' on the excess distribution of $2184 but doesn't have to pay a penalty on distribution because the excess was caused be me taking the AOTC credit on my return.

If anyone has any clue how to make an entry stick in line 2e of the above noted section please post it here. Or if this is confirmation of a BUG/DEFECT...maybe someone knows how to report that to Intuit?

Getting closer....thanks all!

[Hal_Al]

I also have the Ohio  '529CollegeAdvantage'.  It is not a pre paid tuition plan.  Most, if not all, pre paid plans do allow for room and board and other expenses 

[jlar]

My plan was 'prepaid' in that I purchased 'tuition credits' lump sum in 2001. It was called the 'Guaranteed Tuition Fund' or something like that and it was sadly shut down to new contributions in 2003. However, I did speak to them today and they said I could still use it to purchase books or pay for room and board. They also mentioned that you DO NOT have to file the 1099-Q as several have stated (although they seemed a little perturbed that i kept asking them tax related questions LOL)....just keep the details around to prove you had legitimate expenses if you are audited is what they said (again, same as stated many times in this thread).

I also looked up some of the room and board stuff and including room and board charges even when living at home also seems legit - and the colleges will provide cost guidance on their COA statements even for commuters..more than enough there to cover the $4000 taken away to claim the AOTC.

It still seems odd to me, but perhaps the best solution in this case is indeed to DO NOTHING (ie NOT file the 1099-Q on my daughters return). Can't get more simple than that! Then I'll buy the AuditProtection with TurboTax when I file the return so at worst I have to submit some letters as proof.

I still think it would be helpful if someone could confirm the 'form' entries I came up with and help validate that there is a flaw in TurboTax. Someone else could still find this information helpful.

I'm going to finish these up, submit, and hope for the best. 

Many thanks again to the fine folks who provided feedback on this issue.

[jlar]

Still fooling around with how to 'zero out' the 1099-Q.

I had the Form line items wrong in prior posts...

On Form 1099-Q (in Form Mode) - enter in line 2c columns 1 and 2 of section "Qualified Tuition Program (QTP) Computation of Taxable Distribution"

I entered my Adjusted Qualified Expenses, starting with the 1098-T and then deducting the $4000 for AOTC and then adding Books and computed Room and Board charges. This effectively 'zeros out' any additional income and/or penalties. Turbo Tax still shows 1099-Q and 1099-Q Summary forms in the app so I'm thinking those would be submitted (not sure).

@Hal_Al  - thank you again for all your input! One more question:  Do you think it's better to:

1) Just not include the 1099-Q at all and hope not to get a letter form the IRS  (then supply the documentation if you do)

OR

2) Include the 1099-Q now and zero out the charges using the computed qualified expenses and the 'form approach' above. I would think this approach would be less likely to garner any suspicions since the 1099-Q is also provided to the IRS.

I have both options saved and ready to submit one or the other.

[jlar]

"Q. **Can i enter a 1099Q line 2c "Adjusted Qualified Higher Education Expenses applied" amount on my daughters federal return to 'transfer' the amount of 1098-T qualified expenses entered (on my/parent return) and 'stranded' (i.e. in excess of the $4000 AOTC qualification)...plus other qualified costs, such as books, Room and Board, etc.

A.  Yes. In fact, that is the way it should be done. 

[KrisD15]

If the student is your dependent, you can enter the 1099-Q and 1098-T into your TurboTax program. 

If there is a credit, you get that credit.

If there is taxable income (and the 1099-Q was issued to the beneficiary) the student claims the income.

Your TurboTax program should say if the student needs to report anything concerning the 1099-Q and/or 1098-T.

If the education expenses are at least more than 4,000 of the 1099-Q and other assistance, such as scholarships and grants, there is nothing that needs to be reported on the student's return. 

Form 1099-Q is used for a worksheet, it is not reported directly on Form 1040. Only the result would be reported if there is taxable income because of the 1099-Q.

Do keep a copy, as well as the student's account statements, with your tax file. 

IRS Pub 970

[jlar]

Thank you @KrisD15 .

I posted that out of another thread I was participating in but frankly its gotten too messy....enter at your own risk:

https://ttlc.intuit.com/community/college-education/discussion/re-can-someone-answer-[product key re...

I've given up and heading to an accountant to help me figure things out but thanks for replying!

[CruzGalvez]

Hello.

If form 1099Q is not included in the tax form, how does TurboTax estimate the tax on the 529 portion for the trade-off with the American Opportunity Credit.

My son's tuition and fees bill is 9000. Of that, 7,000 is paid with a non taxable scholarship. The remaining 2,000 were paid off with the 10,000 529 distribution (the other 8,000 of the distribution was used for room and board).

The earnings in the 529 account were 2k, basis 8k. Roughly speaking.

So a portion of the 2k has to be taxable, yes?

[KrisD15]

Yes, possibly.

Only if the distribution was used completely for education expenses that are not needed for a credit, and also not needed to offset scholarship, would you not bother to report/enter it. 

Additionally, if having the student claim part of a distribution results in Unearned Income which then requires the student to file and perhaps also to the Kiddie tax, you might be better off allocating Scholarship income to the student. 

Scholarship income is considered Earned Income, which has a higher filing requirement. 

It can also be used by the student to contribute to an IRA.  

[CruzGalvez]

IDK why the Taxact online expert indicated that I didn't need to add the form. Although the form does list our son as the beneficiary and his SS is in it, it makes sense to add it since we ARE claiming the AO credit as well.

[Hal_Al]

Q. My son's tuition and fees bill is 9000. Of that, 7,000 is paid with a non taxable scholarship. The remaining 2,000 were paid off with the 10,000 529 distribution (the other 8,000 of the distribution was used for room and board).  we ARE claiming the AO credit as well.    So a portion of the 2k earnings has to be taxable, yes?

A. Simple answer: yes.  If $4000 of expenses are used to claim the AOC, that's 4000 of expenses no longer available for  the 1099-Q (529 distribution) and/or tax free scholarship. 

But you get to allocate those expenses.  If the scholarship is not restricted to tuition, it is usually better to declare $4000 of the scholarship as taxable, rather than paying tax on the 1099-Q.  You're thinking "How is paying tax on $4000 better than paying tax on $2000?"  Taxable scholarship is "earned income" and the student-dependent gets a bigger standard deduction for that. So, if that is his only income, no tax is due. Technically, he doesn't even have to file a tax return.  But, you may want to do so, to document that he declared it taxable.

If the scholarship is restricted, and you can't shift tuition from it to the AOC;  your numbers, limit you to only using $2000 of tuition (9000 - 7000 = 2000) for claiming the AOC (you get a$2000 credit, rather than the full $2500).  

If only $2000 of expenses are used to claim the AOC, that's 2000 of expenses no longer available for  the 1099-Q (529 distribution).  So, 2000 of the 10,000 distribution is not longer "qualified".  2000 / 10,000 = 20%.  20% of the $2000 earnings is taxable.  0.20 x $2000 =$400 of taxable income goes on the student's return.  If that's his only income he does not need to file since it is less than the $1100 filing requirement for unearned income. 

[collegeparent]

Dealing with a similar situation.  How do I get TT to allow me to report part of my dependent daughter's scholarship as taxable??  

[Hal_Al]

 To make some of the scholarship taxable, you can tell TT how much you want taxable by saying it was used for room &board. Note the wording at that screen “or other expenses”. You didn’t have to literally use the scholarship for R&B.