Did not receive the full $500 child tax credit

[IAMBA94]

 My child is 19 and a full-time college student (since Fall 2020) living at home. The $500 child tax credit that I should have received for this "other dependent" was reduced. I am well under the AGI phase out limits. Last year I received the full $500 but this year it's being reduced to $170. It appears to have something to do with the education portion of the return. I paid all college expenses and was reimbursed from a 529 plan with the distributions going to me. I entered the 1098-T and the 1099 Q, as well as all expenses. Distrubutions from the 529 plan were less than the actual expenses. Expenses included tuition NOT covered by grants/scholarships, room/board, books/supplies. The student does not work and does not have W-2 income and therefore does not file their own return. I'm sure the answer is obvious, but I can't figure it out.

[NCperson]

the $500 credit is a non-refundable credit....meaning Line 22 can not be less than zero. 

what is on line 22? (form 1040)

[IAMBA94]

Line 22 is zero

[NCperson]

then that is why you only received $170 for the other dependent tax credit - as stated it's a non-refunable credit and since Line 22 can't be less than zero, tben the other dependent tax credit can't be more than $170

[Hal_Al · Accepted solution]

 The other dependent credit was reduced from $500 to $170 because that was all that was needed to get your tax to 0 (line 22 of form 1040). It is not related to the 1099-Q

A bigger question might be: what's on line 29 of form 1040? Did you get the full $1000 refundable portion of the American Opportunity credit (AOC).  Since,  distributions from the 529 plan were less than the actual expenses, there may have been enough tuition left over to claim some AOC.  If not, you may want reconsider how you report the 1099-Q.  Making some of it taxable may result in more Other dependent credit and AOC.

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Provide the following info for more specific help:

• Are you the student or parent.
• Is the  student  the parent's dependent.
• Box 1 of the 1098-T
• box 5 of the 1098-T
• Any other scholarships not shown in box 5
• Does box 5 include any of the 529/ESA plan payments (it should not)
• Is any of the Scholarship restricted; i.e. it must be used for tuition
• Box 1 of the 1099-Q
• Box 2 of the 1099-Q
• Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)?
• Room & board paid. If student lives off campus, what is school's R&B charge. If the student lives at home, only the school's board charge for on campus students. 
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers
• How much taxable income does the student have, from what sources
• Are you trying to claim the tuition credit (are you eligible)?
• Is the student an undergrad or grad student?
• Do you expect your tax situation to be about the same for the next 4 years of your student college career (the AOC is a maximum of $2500 [$1500 non refundable] and limited to being claimed 4 times and only  for an undergrad students)

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Qualified Tuition Plans  (QTP 529 Plans) Distributions

General Discussion

It’s complicated.

For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q. 
The 1099-Q gets reported on the recipient's return.** The recipient's name & SS# will be on the 1099-Q.
Even though the 1099-Q is going on the student's return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because he is your dependent.

You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The educational expenses he claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit,  that gets him an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. Another special rule allows you to claim the tuition credit even though it was "his" money that paid the tuition.
In addition, there is another rule that says the 10% penalty is waived if he was unable to cover the 529 plan withdrawal with educational expenses either because he got scholarships or the expenses were used (by him or the parents) to claim the credits. He'll have to pay tax on the earnings, at his lower tax rate (subject to the “kiddie tax”), but not the penalty.

Total qualified expenses (including room & board) less amounts paid by scholarship less amounts used to claim the Tuition credit equals the amount you can use to claim the earnings exclusion on the 1099-Q. 
Example:
  $10,000 in educational expenses(including room & board)

   -$3000 paid by tax free scholarship***

   -$4000 used to claim the American Opportunity credit

 =$3000 Can be used against the 1099-Q 

Box 1 of the 1099-Q is $5000

Box 2 is $2800

3000/5000=60% of the earnings are tax free; 40% are taxable

40% x 2800= $1120

You have $1120 of taxable income  ( in your case, the tax would be wiped out by the additional dependent credit)

**Alternatively; 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." 

***Another alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit. Most people come out better having the scholarship taxable before the 529 earnings. 

[IAMBA94]

This is very confusing! I'm trying to work through your list myself so I understand it. I may have done something wrong last year but not sure. Let me see what I can figure out before just giving you all of the numbers. I need to learn so that I do it correctly in 2022 and future years. I'm also confused as to when a student who has no W-2 income should file their own return. So many pieces to this puzzle!

[Hal_Al]

 A student dependent must file a tax return for 2021 if he had any of the following:

1.          Total income (wages, salaries, taxable scholarship etc.) of more than $12,550 (2021).
2.          Unearned income (interest, dividends, capital gains, unemployment, taxable portion of 529 distribution) of more than $1100.
3.          Unearned income over $350 and gross income of more than $1100
4.          Household employee income (e.g. baby sitting, lawn mowing) over $2300 ($12,550 if under age 18)
5.          Other self employment income over $432, including money on a form 1099-NEC

Even if he had less, he is allowed to file if he needs to get back income tax withholding. He cannot get back social security or Medicare tax withholding.

In TurboTax, he indicates that somebody else can claim him as a dependent, at the personal information section.

[IAMBA94]

My son only had $404 of unearned income so no need to file for 2021. However, now there is a work study job that pays directly to him. There is no withholding of any kind and spring semester he earned $325. I assume this isn't W-2 income, so therefore would be reported as unearned income. He most likely will have enough unearned income to file for 2022 unless student hours for the fall semester are not approved for the job he has. So now the question becomes should any of the 529 distributions for 2022 be in his name/SS#. Until now, all distributions have been to the parents and reported to us because we pay all tuition and expenses, plus we claim him as a dependent. I didn't take out any excess money from the 529 in 2021for reimbursement, so nothing is taxable. In fact, I guess I should have taken out less to maximize the AOC.

[Hal_Al]

The words "work" and "unearned" do not go together. So, no, he will not have unearned income.  If he does not get a W-2, it can still be entered in TurboTax as earned income. 

As long as the 529 distributions are untaxable (used for qualified expenses), it doesn't matter who the distribution is made to.  If some of it is going to be taxable, the first $1100 of taxable earrings is taxed at the student's marginal rate (usually 10%), on his return. After that it will be taxed at the same rate, whether it's reported by the student or parent (the "kiddie tax" kicks in). 

You say "I guess I should have taken out less to maximize the AOC".   If you tax liability is already 0, only the refundable portion of the AOC can increase ($1000 maximum). An alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit. Most people come out better having the scholarship taxable before the 529 earnings. 

Details:

There is a tax “loop hole” available. The student reports all his scholarship, up to the amount needed to claim the American Opportunity Credit (AOC), as income on his return. That way, the parents  (or himself, if he is not a dependent) can claim the tuition credit on their return. They can do this because that much tuition was no longer paid by "tax free" scholarship.  You cannot do this if the school’s billing statement specifically shows the scholarships being applied to tuition or if the conditions of the grant are that it be used to pay for qualified expenses.

Using an example: Student has $10,000 in box 5 of the 1098-T and $8000 in box 1. At first glance he/she has $2000 of taxable income and nobody can claim the American opportunity credit. But if she reports $6000 as income on her return, the parents can claim $4000 of qualified expenses on their return.

Books and computers are also qualifying expenses for the AOC. So, extending the example, the student had another $1000 in expenses for those course materials, paid out of pocket, she would only need to report $5000 of taxable scholarship income, instead of $6000.

A student can have as much as $12,550 of earned income and scholarship income before he pays any tax.  But unearned income is taxed after $1100.