Why does our full time student need to pay taxes on their 529 Withdrawal for college?

[Janik1]

We withdrew funds from our son's 529 account to pay for his freshman year college expenses. The withdrawal precisely covers his acceptable college expenses (we did not withdraw more than his actual college expenses). My wife and I are reporting him as a dependent on our joint return and received the American Opportunity Credit. Our first question is, does our son also need to submit a Federal Tax Return as well because the 1099-Q form is listed in his name with his information on the form? Assuming that he does, we started to file his Federal Tax Return. He has $0 earned income and $250 unearned income for the year. However, Turbotax is currently showing that he has "Total Income" of $2K (because of the 1099-Q information that was included) and owes money. Does this sound accurate? Would he be taxed for his 529 distribution in this scenario? Appreciate any help that you can provide. Thank you very much.

[KrisD15]

Your TurboTax program should tell you what the student needs to claim. You needn't enter the 1099-Q into his program, only the amount he needs to claim. 

Your account should include a 1099-Q worksheet with the numbers you need to file for the student. 

Enter the income the student needs to claim (simply the dollar amount) as "Other Income" so that it is reported on Schedule 1 and line 8 on the 1040. 

Enter the taxable earnings portion:

Income

Scroll down to "Less Common Income"

Scroll down to "Miscellaneous Income"

"Other Taxable Income"

The American Opportunity Tax Credit only needs 4,000 expenses to be maxed out. Having the student claim more than that is silly. 

If you have a choice of the student claiming scholarships versus distribution, you may want to opt for the scholarship. The effect on your return would be the same. The distribution could throw the student's income over the limit for "Unearned Income" whereas the scholarship is considered "Earned Income" and listed on Line 1 of the 1040. The amount of tax-free earned income for the student usually has a higher limit than unearned. 

Enter scholarship income under:

Income

Scroll down to "Less Common Income"

Scroll down to "Miscellaneous Income"

"Other income not already reported on a Form W-2 or Form 1099"

[Janik1]

Thank you for your help.