Reconciling 529 Disbursement with Medical Costs Claimed for Special Education

[SactoKid2]

I have a dependent with a learning disability and a written diagnosis from a medical doctor.  As a result, we have significant costs for long-term medical treatment in the form of a tuition for her High School, which specializes in her learning disability. We’ve also withdrawn $10,000 from her 529 to help with those costs.  In order not to double claim expenses on our 2022 return and to avoid a penalty on the 529 distribution, I’ve reduced the medical costs associated with the tuition on our return by the earnings (block 2) reported on the 1099Q. 

Should I have reduced the medical costs of the tuition by the entire $10,000 of the 529 distribution, instead?  I did not include the cost basis (block 3) of the 1099Q, because the contribution was made after taxes.  As much as I do not wish to double claim an expense, I do not think it fair to be taxed twice on the cost basis.  If you advise otherwise, please provide the rationale that counters my reasoning.  Thanks.

[AmyC]

The 1099-Q must only be entered if it is greater than the eligible expenses. If all of the $10,000 went towards eligible expenses, tuck the form in your folder.

You are correct that you can't double dip and claim medical expenses with some of the money.  Your method sounds logical but is not quite right. See the first reference below for calculation and examples.

If you are claiming that not all of it went toward qualified expenses, then you will need to enter it and eligible expenses.

Reference:

• Reporting 529 Plan Withdrawals on Your Federal Tax Return 
• Guide to IRS Form 1099-Q

[SactoKid2]

Thank you for your reply, along with the articles you provided.  As context, can you expand on what is “not quite right” about my method?

First, in direct reply to the first and third paragraphs of your response, all of the $10,000 went to qualified expenses – i.e. High School tuition that far exceeds the $10,000.  And “yes” all of the $10,000 went to that qualified expense.  So that leaves your second paragraph which indicates that my method is “not quite right”, referring to calculations and examples in the first linked article to elaborate.

I find the example calculations in the article you provided insufficient without further guidance.  The article shows how to calculate Adjusted Qualified Education Expenses, if education credits are applied.  However, education credits are not involved in my situation.  Instead, I have medical deductions involved.  I’m sure you know that the tax benefit from credits is much easier to specify than that of deductions.  Please clarify if you are recommending that I convert the medical deduction from the Special Education tuition into a tax benefit value, in order to calculate the Adjusted Qualified Education Expense.  And if that is what you recommend, what method does one use to convert a deduction into a discrete tax benefit?

Thanks again.

[Hal_Al]

Q.  I’ve reduced the medical costs associated with the tuition on our return by the earnings (block 2) reported on the 1099Q.  Should I have reduced the medical costs of the tuition by the entire $10,000 of the 529 distribution, instead?  

A. Yes.

Tax is only calculated on the earnings portion (box 2 of the 1099-Q).  but in determining that amount, you compare the qualified expenses to the total distribution. 

 
Example:
  $8,000 in educational expenses(including tuition qualified Medical )

Box 1 of the 1099-Q is $10,000

Box 2 is $3000

8000/10,000 = 80% of the earnings are tax free; 20% are taxable

20% x  3000 = $600

There is  $600 of taxable income on the recipient’s (the parent in this case) return (plus 10% penalty)

[SactoKid2]

Thanks for your reply, but I don’t think your reply applies to my case or my concern.

Let me clarify that the Tuition for Special Education expense for my dependent far exceeds the $10,000 of the 529 distribution.  I only withdrew $10,000, because that’s the most I can withdraw in any tax year for a qualified High School expense without a penalty. 

In your example, you have “$8,000 in educational expenses (including tuition qualified Medical )”.   Although the tuition qualified medical expenses that I have far exceeds $10,000, I’ll just plug in $10,000 into your example, which would result in 0% taxable and no penalty.  Any expense greater than $10,000, which is applicable to my case, would have the same result. 

Since the High School tuition is both a qualified education expense and a qualified medical expense (i.e. Special Education), my concern is to determine how much of the tuition I can now claim as a medical expense and ensure there is no double-dipping in my return.  Since, the cost basis (block 3) of the 1099Q was contributed after taxes, I believe I should only reduce the tuition I claim as a medical expense by the earnings (block 2), which have not yet been taxed.  I’m looking for reasons why I should also include the cost basis in medical expense reduction, allowing those funds to be taxed a second time.

[AmyC]

The 1099-Q is our first priority and Hal_Al is correct that you want to use it first. Avoid tax, penalty and no entry needed now. You can divide up your eligible expenses as you see fit. The IRS allows you to wrangle the numbers. Just keep a record so you know how you allocated income, in case they ask.

Only money that has been taxed can be used as a medical deduction on sch A. Medical items covered by health insurance and pre-tax dollars do not count as medical expenses.

Reference:

• Publication 502, Medical and Dental Expenses
• IRS Publication 970, Tax Benefits for Education.

[SactoKid2]

Thanks.  I think I know what to do now.