1099-Q - distributions being taxed incorrectly?

[mdsttuser]

In 2020 I had a couple of distributions (to me) from a qualified 529 plan for tuition and expenses for my dependent child.  I received the 1099-Q and entered the information into TurboTax (as I have for the last several years).  I included 1099-T information + additional allowable expenses, the sum of which is less than the total distribution from the 529.  However, I also used the money to pay off outstanding student loans in my child's name - given the SECURE Act of 2019 changes allowing up to 10K (lifetime) in student loan payments to be used from the 529 distribution.  I entered the loan payment information in TurboTax when prompted.  The sum of the tuition + additional expenses + loan payments exceeds the 529 distribution amount, as expected and planned.   However, In looking at the resulting taxes (owed) and the generated tax forms, I see that TurboTax is not considering the loan payments in the distribution calculation and thus the excess distribution is being treated as additional income and is being taxed, with the added 10% penalty.

Looking at the forms within TurboTax, the Qualified Tuition Program question "Did the student make any education loan payments to treat as expenses?", the answer is Yes in the student worksheet (Part I 4a).  In Part VIII (Apprenticeship and Education Loan Smart Worksheet) of the same worksheet I can see where the principal and interest information for the student loan payments were entered, and the calculations following that show "Earnings taxable to recipient" results in $0.

It appears though, despite the loan payment and the calculations above, that TurboTax has created a Form 5329-T showing "distributions included in income from a...QTP...account" equal to the 529 total distribution minus tuition + expenses, leaving out the loan payment information.  This  $$ amount shows on the Amount subject to additional tax and the subsequent 10% additional tax.  This information is carried forward on 1040 Schedule 1 line 8 "Other income" from QTP.

I guess my question is why is this happening?  I tried deleting the 5329-T form and re-entering information and nothing seems to make a difference.  What am I missing?

Any help would be greatly appreciated.

[AmyC]

You may be able to delete the 1099-Q, the 1098-T and the student loan interest.

• If the 1099-Q was used for qualified expenses, it can be deleted from your return. Only taxable income from the 1099-Q must be reported. See Reporting the 1099-Q for more.
• You are not required to file the 1098-T, if you are not using any education credit, you can delete the 1098-T. 
• The student loan interest paid by the 529 is not deductible. Only interest paid with funds other than the 1099-Q qualify for a deduction.

You may have some education credit available You did not mention room and board. See my 529 example. You may have had a little bit of money left for some AOTC credit.

I tried to replicate your situation and was not able. I entered a 1099-Q with education expenses and student loan interest without a 5329 generating. There is more to this story. Please read the links above and reply back with any additional information or help needed.

[mdsttuser]

Thanks for the response.  I am not entirely sure you understood the situation.  Let me try and re-explain.  I apologize if my sequencing of events is messed up, I have been through this several times now in TT and am going by memory now.

I had entered my child's 1098-T information including tuition and a small scholarship (about $3500).  Additionally, I entered other expenses such as books, room and board, and software costs - all eligible expenses for the 529 plan.

I entered the information from the 1099-Q.  Within TT, after the summary information for the 1099-Q, when you continue, there is a prompt under the heading "Principal or interest payments on qualified education loans" which asks, "Did you make any payments on qualified education loans of the designated beneficiary?".  I answered YES to this prompt and then subsequently entered the "Principal Paid" and "Interest Paid" amounts and indicted I would NOT be deducting the interest as an expense because the loan is in my child's name, not ours.  The total amount of principal and interest paid was not to exceed $10,000. 

As a side note, when I added additional educational expenses, I was a little puzzled by the additional prompt at the bottom of the education expenses screen "Did you take a tax free distribution from a 529 plan for payments towards a qualified education loan?".  Isn't this a repeat of what I already answered earlier?   I tried yes and no and it didn't make a difference.

Anyway, the sum of the tuition + books, expenses, room and board, and software was less than the 529 distribution as I stated earlier.  However, the 2019 tax law changes allow payment of up to $10,000 in educational loans with 529 distributions tax free.  When I add on the amount I paid towards qualified student loan principal and interest the sum of all the parts (tuition, books, room and board, loans) was greater than the 529 distribution.  So, there shouldn't have been any extra distributions for which I was taxed and/or penalized.

This whole thing has me very confused at this point.  Even more so when I went in and removed the information pertaining to educational loans paid (i.e. principal + interest) + noticed my tax amount owned went DOWN.  On the schedule 1 I also noticed that 1/2 the scholarship amount was now excluded from taxable income, and was applied towards the 529 distribution amount.  Probably lost you there though.

Anyway, it seems that what should be a benefit to me, using the 529 funds to pay off the student loan, is causing me to incur more taxes than simply leaving it off, which is opposite of what I would have expected.

I know that without knowing my exact tax situation, which I won't post online, it is hard for you to follow along, but if you can provide assistance, that would be great. 

[AmyC]

Paragraph 4: The program asked about the tax free distribution as a double check since that disallows the deduction of student loan interest on the return.

Paragraph 5: Correct, all of your 529 was used for allowed expenses and therefore, does not need to be reported.

Paragraph 6: Yep, you lost me there. I am not following how taxable scholarship can be applied to 529 distribution. Again, no 529 in program, seems simpler to me.

Paragraph 7: The point of the 1099-Q is simply for you to pay tax on anything that was not spent on qualified expenses. Again, if not needed to report income, delete the 1099-Q.

Let's also be clear:

• whoever claims the student, claims the tuition deduction.
• Only the student claims the scholarship income.
• Student loan interest must meet these qualifications, see  Topic No. 456 Student Loan Interest

.

In conclusion,

delete the 1099-Q.

Any interest paid using the 529 is not allowed to be claimed. Only claim any interest paid without using the 529.

As for the 1098-T, you have taxable scholarship income and want to keep the 1098-T. You can and adjust expenses paid by the 529 or

I would also delete the 1098-T and enter the scholarship income  See Where do I enter scholarship income?

[mdsttuser]

Thanks for the reply.

I understand that the 1099-Q need not be reported if the entire distribution is accounted for with the expenses + student loan payments (assuming <= 10,000).   I also understand based on your response that I can delete the 1099-Q from TT since it isn't necessary.

What I do not like is that TT is asking me (someone that isn't a tax expert) if I received a 1099-Q, which I did.  I enter the 1099-Q.  I then enter in all my expenses, I enter in the loan payment information.  The total of all these expenses is > the 529 distribution reported on the 1099-Q and my taxes go UP.  The student worksheet Part VIII line 8 shows "Earnings taxable to recipient..." as $0.  Yet, on Schedule 1 Part I, line 8 and 9 it shows $5,500.  This amount is carried forward to the 1040 form and I have to pay taxes + penalty on it.

To me, it seems something isn't working correctly within the software or the Schedule 1 would NOT show any excess income from the 529 plan - based on what I explained from the student worksheet.

I appreciate your time.  Based on your response it would seem you are saying I need to say NO I did not receive a 1099-Q (when I did) and/or delete the 1099-Q forms from the project.  I guess that's what I will have to do, but it  just doesn't seem right.   I have never had this issue before when entering the 1099-Q information, but this is the first year my expenses didn't exceed the distribution without the loan (which I know is new since 12/2019).

[KrisD15]

Not to muddy up the thread, but it is imperative to enter the 1099-Q FIRST before the 1098-T.

The TurboTax program Step-By-Step is set up that way. 

The reason is that the program will allocate 10,000 expenses (if available ) for a credit after the 1098-T is entered. 

If the 1099-Q has been enter first, that amount will be considered. If not, then not. 

If the 1099-Q is entered after, the program won't release that 10,000 unless the customer goes through the education interview all over again and then re-allocates the expenses. 

I'm not a programmer, but this is the way I see the program working.    

[mdsttuser]

Thanks for the response.   I did that originally as I always go step by step from the beginning (after loading the previous year's returns), but I just deleted the 1099-Q and 1098-T sheets, as well as the student worksheet and re-entered everything, 1099-Q first, and it didn't make any difference.  For whatever reason, TT doesn't seem to want to consider the usage of 529 funds for the student loan payment as valid expenses for the plan and considers it taxable income.  In fact, if I remove the principal and interest amounts entirely my taxes owed actually goes down, which makes absolutely no sense at all.  

At this point I give up.  I'm just lucky I caught it or I would have paid more than $2K in taxes that I don't owe.  Hope others with a similar situation double check everything before they file.

Thanks for trying to help.

[ptdusky]

The problem I see with deleting everything is that the distribution to pay the loan is non-qualified in NY and I need it to transfer to the NY return.  Suggestions?

[mdsttuser]

Not sure if this will help you, but.....

I decided I didn't want to delete the information, mainly because I felt better having the information within my tax records, and the thought of deleting it just to get around what was, at least to me, clearly a turbo tax issue seemed wrong.  In then end I figured out a way around the turbo tax issue.

It appears that turbo tax was allowing entry of the 529 distribution and indicating how much of it was being used to pay off student loans.  However, they did not appear to be using that information on on the Form 1099-Q in section "Qualified Tuition Program (QTP) Computation of Taxable Distribution" line 2.a.   So what I did was go into the 2 1099-Q forms inside turbo tax form mode and I and manually entered appropriate values (split between the two 1099 forms) to account for the total distribution amount that went towards student loan payments - up to the $10K limit.    Once I did this, everything else worked out and I could both keep my 1099 information AND not pay unnecessary and unwarranted taxes on the distribution.

Hope this helps.

[mtfarley1]

I have a similar situation.  I entered the 1099-Q information and had more than enough expenses to cover the distribution.   TT taxed some of the distribution and earnings.   I spoke with my 529 provider (Vanguard), and they recommended that I NOT enter the 1099-Q or expenses as Amy just responded.   Vanguard were well aware of the issue.

[Marcy17]

I think Turbo Tax handles 529s incorrectly. It seems to always make it taxable, even if the expenses exceed the amount of the 1099-Q basis and earnings reported. I have tried to resolve this problem for years. They at first told me that if I take an educational credit than I have to tax some 529 as it is "double-dipping". This year I took off the educational credit to try and make none of it taxable and it did not change the amount that was taxed. That form did not change at all. This is very frustrating.

[mtfarley1]

Marcy17,

Yes, TurboTax, and also my accountant's software miscalculates the taxable basis of the 529 in conjunction with the 1099-Q/1098-T.  I had the same dilemma, so I called up Vanguard's 529 plan and they told me not to report the 1099-Q or 1098-T if my qualified expenses exceeded the 529 distribution.  There is also a earlier thread on this community pages that states the same and has a link to an article.  

Search for 529 and the top hit updated a few minutes ago with help.  Here is a link to the outside article.  

https://www.savingforcollege.com/article/reporting-529-plan-withdrawals-on-your-federal-tax-return

Yes, it is frustrating.  I wonder if the actual IRS worksheet is incorrect also?

[RonaldB]

I have a slightly different issue.  My son is a freshman (started school in the fall of 2021).  Morgan Stanley manages my son's Bright Directions 529.  They counted a distribution on 1/4/22 for the Spring 2022 semester that had assets sold on 12/31/21 in the 1099-Q for 2021 year-end.   I told the representative that I did not authorize the assets to be sold on 12/31/21.  I told them the check needed to be received by 1/13/22.  This caused an issue where the school received the check directly from Morgan Stanley by 1/13/22 but they showed in the 1098-T the tuition for fall semester 2021 only.  Morgan Stanley said they could not correct the 1099-Q to show how much was actually disbursed in 2021.  This causes issues in Turbo Tax.  I don't know the best way to present the situation in Turbo Tax since all actual distributions were used for qualified expenses.  I don't know if I can show the 1099-Q, the way it should be or not report the 1099-Q in Turbo Tax.  I need help. 

[AmyC]

You probably do not need to enter the form. If the entire 1099-Q went to qualified expenses, room and board, tuition, etc then you do not need to enter the form. Tuition paid first 3 months of next year also qualify, see page 12 What Expenses Qualify and page 52 for qualified distributions at IRS Publication 970, Tax Benefits for Education.

@RonaldB