AOTC and adding back 529 income

[jasdlm]

Dependent has a 529 distribution from an account in his name.  I want to add back the earnings and take the AOTC on the parent return.  Is this like scholarships, where I can add the 1099Q earnings back to the dependent's return since it's in his SSN?  Then take the AOTC on the parent return?  Doesn't pass the sniff test, but seems to line up with the treatment of scholarship income.  I can't seem to find anything on point in trying to research this.  Thanks much!

[Randall]

I'm not sure if this applies to you.  But 529 qualified expenses includes much more than the AOTC qualified expense.  Room and board.  Even if they're living at home, I think there's a chart for the school area you can use for 'room and board' expense.

[TexTaxToo]

To answer your original question, yes, you can take the AOTC, reduce the amount of qualified expenses, and potentially pay the additional tax on the distribution, as described here:

https://www.irs.gov/publications/p970#en_US_2020_publink1000178546

But as Randall said, it's best to try to find expenses that aren't qualified for the AOTC that are allowed for 529 plans to "use up" the distribution.

[TexTaxToo]

One more thing - the 10% penalty doesn't apply in this case (for the portion of the expenses attributed to the AOTC)!!!

[jasdlm]

6 hours ago, TexTaxToo said:

To answer your original question, yes, you can take the AOTC, reduce the amount of qualified expenses, and potentially pay the additional tax on the distribution, as described here:

https://www.irs.gov/publications/p970#en_US_2020_publink1000178546

But as Randall said, it's best to try to find expenses that aren't qualified for the AOTC that are allowed for 529 plans to "use up" the distribution.

To confirm, if there is tax to be paid on the distribution, can it be paid on the student's return with parents taking the AOTC on Parent return?  (1099Q is in SSN of Student)

[TexTaxToo]

Yes, as in the example I linked to:

Quote

Sara's parents claimed an American opportunity credit of $2,500 (based on $4,000 expenses).

... (calculation of taxable amount)

Sara must include $735 in income (Schedule 1 (Form 1040), line 8). This represents distributed earnings not used for adjusted qualified education expenses.

 

(Only the portion of the distribution representing earnings is taxable.)

[jasdlm]

Thank you very much!

[Gail in Virginia]

I am totally unsure about this, but would the earnings on the 1099Q from the 529 plan be counted as unearned income so even if it is reported on the kiddo's return it might have to be taxed at the parent's rate?

[TexTaxToo]

Yes, just like scholarship income.

(Scholarship income has the advantage that it is treated as earned income for the purpose of determining a filing requirement - but once there is a filing requirement, it is unearned income for the kiddie tax.  I believe the 1099-Q income would be unearned for all purposes.)