DS First Semester @ College - Florida Prepaid / 529 / Scholarship / Taxes CONFUSION!

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Take_Five
Posts: 37
Joined: Mon Mar 14, 2011 7:45 am

DS First Semester @ College - Florida Prepaid / 529 / Scholarship / Taxes CONFUSION!

Post by Take_Five »

So, the first of my three sons headed off to college this Fall (online and socially distanced in his dorm room...) and I finally got to see how my best-laid plans for College savings would unfold.... but unfortunately some unexpected things have soured the situation and left me feeling quite confused and distraught. Perhaps someone would have some advice, at least on how best to move forward in future semesters... any help or advice would be greatly appreciated!

I was very proud of my plan, proactively saving for my kids' education from an early age. My goal was to provide undergrad at a public university and that they could graduate debt free. My approach was:

1.) DS1 and DS2 both got "Florida Pre-paid" plans (TUITION ONLY.) By the time DS3 came around, it was no longer a decent deal, IMO. I am starting to think now that it never was a decent deal, and in fact, is a really bad deal (more on that below.)
2.) I set up 529s for DS1, 2,& 3 and made monthly contributions - which, with an assumed rate of return, I calculated to cover other qualified 529 expenses (FEES, BOOKs, ROOM AND BOARD.) These accounts grew significantly - and now I have significant concerns about being able to use this money (see below.)
3.) Early-on, I also set up two ESA (Coverdell) for DS1 and 2 at Vanguard, and made a one-year contribution. This account grew significantly as well, adding to my over-funded college plan.

Sounded like a good approach to me... except I didn't foresee a couple things...

DS1 got into the University of Florida and got the full Florida Bright Futures Scholarship (proud of him!) Again, two great things.... how could this go wrong? Here's what happened with the University Bursar's office:

1.) All Florida universities apply the Prepaid plan first as a default - this took care of TUITION (leaving FEES and R&B)
2.) His Bright Future scholarship was dumped into the Bursar's account and was applied to the remaining FEES and his DORM (we decided not to get a meal plan, he's paying for food as he goes.)
3.) Our remaining out-of pocket expenses amounted to ~$450 (and his food.)

I looked at removing money from his 529 for item #3 and found an article about avoiding 529 withdrawal mistakes. This was the first time that I saw "American Opportunity Tax Credit" AOTC. My MFJ MAGI falls within requirements to qualify for this tax credit - but it requires that you spend $4000 out of pocket for Tuition and Fees ONLY to get the $2500 tax credit. It appears that by having purchased a pre-paid tuition plan (which I now see is like a less-flexible 529 account...) it appears that you basically negate the ability to get AOTC. The Florida universities apply this to tuition first (unless you opt out, in which case you're not using the plan you purchased) and then the Bright Futures eats up the rest of the Fees, Books. If I am seeing this correctly, this is beyond depressing - I paid for a Tuition plan, that in reality had very minimal growth over ~15 years, which now prevents me from getting AOTC. To make matters worse, the Bright Future's scholarship doesn't all get applied to Tuition - only Fees and then the Dorm. My understanding is that Scholarships that don't go against tuition and fees become taxable! So, not only does the prepaid prevent me from getting AOTC, it also pushes a large part of the scholarship into taxable space!

The final problem is in regards to the 529 & ESA accounts - maybe it's a good problem to have, but still a problem - I can take for the remaining $450 and up to the school's Cost of Attendance for food (equivalent to the 7-day meal plan cost.) But I am nowhere near getting withdrawals to deplete the account - and I have 3 529s and 2 ESA ready to go, with DS2 somewhat unlikely to go on to higher education and DS3 likely to get similar scholarships as DS1.

So to summarize my problems/disappointments and questions:

Problem 1.) AOTC appears to be eliminated by my DS' FL Pre-paid plan and scholarship since the plan covers tuition and scholarship covers the rest. So, I miss out of $2500 of free money because I actually spent money on a Pre-paid tuition plan ~14 years ago? The pre-paid plan covered about $1640 for the semester; my basis of which was ~ $1367. So, for 2 semesters a year, I actually spent a little more than the tax credit in order to not get the tax credit... I am baffled; is this correct? It seems the Pre-Paid plan is like a regular 529 but with a lousy return (I knew it was conservative) and you don't have the option of how it gets applied... Am I looking at that right? Other than opting out and not using my plan, is there anything I can do to qualify for some AOTC?

Problem 2.) Part of DS' Scholarship becomes taxable due to Pre-paid plan. Because pre-paid gets applied to tuition first, the scholarship then covers Fees and then mostly the dorm room - which in my understanding makes this portion taxable? Do I have to claim this to pay the tax for or can I have my son file (still as a dependen)t and claim the scholarship (he has not had to file yet) to minimize the tax burden?

Problem 3.) Overfunded 529 accounts - I realize that I can transfer these accounts to a sibling, but I already have accounts for each sibling (and DS2 in somewhat unlikely to use it...) I know these can also be used for Grad / Med School so I would probably just hold on to the money until each kid has moved on... but there are also some other ideas & questions - For DS1 I will take the $450 out, and also for food this semester (up to the COA). If DS1 lives off-campus in the future, I can also withdraw for room & board; but it bugs me that the scholarship is still taxable... it seems silly to not use the scholarship funds, but withdraw from the 529 to pay for R&B. I have read that you can withdraw penalty free an amount equal to the scholarship - but does that apply when part (a majority) of the scholarship is not being used for tuition (but R&B)? I have read that I need to send any withdrawal directly to DS - although I paid for the balance of $450 with my credit card? does that matter if I am still claiming him as a dependent or do I want to have him file to claim his scholarship as taxable and also report the 529 withdrawal? Should I roll the ESAs into 529 to offer a little more flexibility or at least having my eggs in one basket? OK, now my head is starting to hurt.

I know we're in a fortunate position, but man, the pre-paid quandary just seems to be a crappy deal all around. I'm sure there are others in this situation; I'd be most grateful to anyone that can enlighten me, correct me, or provide advice on how to optimize this for the future. Thanks in advance.
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teen persuasion
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Re: DS First Semester @ College - Florida Prepaid / 529 / Scholarship / Taxes CONFUSION!

Post by teen persuasion »

I haven't used 529s or prepaid plans, so no info there, but we have claimed scholarships as taxable income for the purpose of qualifying for AOTC.

We have the student claim the appropriate amount as taxable scholarship (it goes in with wages, but a note is made on the comment line to the left (Scholarship)). Its a little quirky trying to find the correct section in Turbotax to include it, I have to search around every year (you don't just enter the amount as wages). Generally it is falls within the student's standard deduction on federal (unless they have earned income, too), but might trigger state income taxes. We pay any additional tax for them, since it nets us a larger refund (but we run the numbers both ways to check).

Just a few weeks ago we received a notice from the state tax board - they thought we didn't qualify for the state tuition credit in 2018, because DS4's 1098T said scholarships exceeded tuition. They were only looking at our tax return, not his, and on his state tax return there is no place for the "taxable scholarship" notation - the income just flowed down from the federal return looking like wages. So they had no way to know he'd claimed some of his scholarships as taxable, and paid tax on it. We had to submit a protest and documentation to clarify; I uploaded copies of his returns and explanations. Just got the notice yesterday that they accepted my information and cancelled the assessment. That is the first time I've had an issue with this; never triggered any issues with the 3 older kids while they were in college, and DS4 is finishing up this year.

Big piece of advice: take screenshots of online billing statements. At most of the kids' schools the info was ephemeral, it wasn't archived or accessible after the next monthly statement went up. Things like financial aid gets applied, and changed, and removed. You want to have the breakdown of tuition/required fees/other fees/room/board and scholarships/grants/loans/payments for each semester and each calendar year. We'd have trouble at tax time trying to find the details which had gone poof after the new semester started and the old one's info fell off (or last spring, which was a different academic year).

Some schools bill both semesters in one calendar year (spring is billed early December). This makes it easier for things like AOTC which are calendar year. Other schools don't bill spring semester until after January, which gives you a 5 year span (1/2, 1, 1, 1, 1/2) - much less clean for AOTC, but might be an opportunity to take LLL the first or last year.
Minty
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Re: DS First Semester @ College - Florida Prepaid / 529 / Scholarship / Taxes CONFUSION!

Post by Minty »

One thought: The Wiki says that if a beneficiary received a scholarship, then money can be withdrawn from the 529 plan in the amount of the scholarship without penalty. Also, of course, income tax is payable only on the gain.
Core Four w/ nominal bonds & TIPS. Refi Rampage: Purchase: 3.875% 30 -> R1 3% 20 -> R2 2.375% 15 -> R3 1.99% 15
Broken Man 1999
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Re: DS First Semester @ College - Florida Prepaid / 529 / Scholarship / Taxes CONFUSION!

Post by Broken Man 1999 »

Take_Five wrote: Fri Nov 20, 2020 3:07 pm So, the first of my three sons headed off to college this Fall (online and socially distanced in his dorm room...) and I finally got to see how my best-laid plans for College savings would unfold.... but unfortunately some unexpected things have soured the situation and left me feeling quite confused and distraught. Perhaps someone would have some advice, at least on how best to move forward in future semesters... any help or advice would be greatly appreciated!

I was very proud of my plan, proactively saving for my kids' education from an early age. My goal was to provide undergrad at a public university and that they could graduate debt free. My approach was:

1.) DS1 and DS2 both got "Florida Pre-paid" plans (TUITION ONLY.) By the time DS3 came around, it was no longer a decent deal, IMO. I am starting to think now that it never was a decent deal, and in fact, is a really bad deal (more on that below.)
2.) I set up 529s for DS1, 2,& 3 and made monthly contributions - which, with an assumed rate of return, I calculated to cover other qualified 529 expenses (FEES, BOOKs, ROOM AND BOARD.) These accounts grew significantly - and now I have significant concerns about being able to use this money (see below.)
3.) Early-on, I also set up two ESA (Coverdell) for DS1 and 2 at Vanguard, and made a one-year contribution. This account grew significantly as well, adding to my over-funded college plan.

Sounded like a good approach to me... except I didn't foresee a couple things...

DS1 got into the University of Florida and got the full Florida Bright Futures Scholarship (proud of him!) Again, two great things.... how could this go wrong? Here's what happened with the University Bursar's office:

1.) All Florida universities apply the Prepaid plan first as a default - this took care of TUITION (leaving FEES and R&B)
2.) His Bright Future scholarship was dumped into the Bursar's account and was applied to the remaining FEES and his DORM (we decided not to get a meal plan, he's paying for food as he goes.)
3.) Our remaining out-of pocket expenses amounted to ~$450 (and his food.)

I looked at removing money from his 529 for item #3 and found an article about avoiding 529 withdrawal mistakes. This was the first time that I saw "American Opportunity Tax Credit" AOTC. My MFJ MAGI falls within requirements to qualify for this tax credit - but it requires that you spend $4000 out of pocket for Tuition and Fees ONLY to get the $2500 tax credit. It appears that by having purchased a pre-paid tuition plan (which I now see is like a less-flexible 529 account...) it appears that you basically negate the ability to get AOTC. The Florida universities apply this to tuition first (unless you opt out, in which case you're not using the plan you purchased) and then the Bright Futures eats up the rest of the Fees, Books. If I am seeing this correctly, this is beyond depressing - I paid for a Tuition plan, that in reality had very minimal growth over ~15 years, which now prevents me from getting AOTC. To make matters worse, the Bright Future's scholarship doesn't all get applied to Tuition - only Fees and then the Dorm. My understanding is that Scholarships that don't go against tuition and fees become taxable! So, not only does the prepaid prevent me from getting AOTC, it also pushes a large part of the scholarship into taxable space!

The final problem is in regards to the 529 & ESA accounts - maybe it's a good problem to have, but still a problem - I can take for the remaining $450 and up to the school's Cost of Attendance for food (equivalent to the 7-day meal plan cost.) But I am nowhere near getting withdrawals to deplete the account - and I have 3 529s and 2 ESA ready to go, with DS2 somewhat unlikely to go on to higher education and DS3 likely to get similar scholarships as DS1.

So to summarize my problems/disappointments and questions:

Problem 1.) AOTC appears to be eliminated by my DS' FL Pre-paid plan and scholarship since the plan covers tuition and scholarship covers the rest. So, I miss out of $2500 of free money because I actually spent money on a Pre-paid tuition plan ~14 years ago? The pre-paid plan covered about $1640 for the semester; my basis of which was ~ $1367. So, for 2 semesters a year, I actually spent a little more than the tax credit in order to not get the tax credit... I am baffled; is this correct? It seems the Pre-Paid plan is like a regular 529 but with a lousy return (I knew it was conservative) and you don't have the option of how it gets applied... Am I looking at that right? Other than opting out and not using my plan, is there anything I can do to qualify for some AOTC?

Problem 2.) Part of DS' Scholarship becomes taxable due to Pre-paid plan. Because pre-paid gets applied to tuition first, the scholarship then covers Fees and then mostly the dorm room - which in my understanding makes this portion taxable? Do I have to claim this to pay the tax for or can I have my son file (still as a dependen)t and claim the scholarship (he has not had to file yet) to minimize the tax burden?

Problem 3.) Overfunded 529 accounts - I realize that I can transfer these accounts to a sibling, but I already have accounts for each sibling (and DS2 in somewhat unlikely to use it...) I know these can also be used for Grad / Med School so I would probably just hold on to the money until each kid has moved on... but there are also some other ideas & questions - For DS1 I will take the $450 out, and also for food this semester (up to the COA). If DS1 lives off-campus in the future, I can also withdraw for room & board; but it bugs me that the scholarship is still taxable... it seems silly to not use the scholarship funds, but withdraw from the 529 to pay for R&B. I have read that you can withdraw penalty free an amount equal to the scholarship - but does that apply when part (a majority) of the scholarship is not being used for tuition (but R&B)? I have read that I need to send any withdrawal directly to DS - although I paid for the balance of $450 with my credit card? does that matter if I am still claiming him as a dependent or do I want to have him file to claim his scholarship as taxable and also report the 529 withdrawal? Should I roll the ESAs into 529 to offer a little more flexibility or at least having my eggs in one basket? OK, now my head is starting to hurt.

I know we're in a fortunate position, but man, the pre-paid quandary just seems to be a crappy deal all around. I'm sure there are others in this situation; I'd be most grateful to anyone that can enlighten me, correct me, or provide advice on how to optimize this for the future. Thanks in advance.
Would you have been happier if there were no scholarships given, and you would have been able to secure that $2500? DDs received scholarships, but we suffered through the process of using the plan for other expenses.

When I bought the Florida prepaid tuition plans for our DDs I also paid for the fees as a separate payment.

When I started my two oldest grandchildren's' tuition plans, there was also a fee plan. Later on, the prepaid tuition plans started including the fees as well as the tuition in a single payment.

The plans are all paid off, and I have received two rounds of refunds (2017 and 2020) as the tuition hasn't ticked up as much as had been expected. This year I received a refund of about $30,000 total refund from the four plans.

Broken Man 1999
“If I cannot drink Bourbon and smoke cigars in Heaven then I shall not go. " -Mark Twain
cshell2
Posts: 478
Joined: Thu May 09, 2019 10:29 am

Re: DS First Semester @ College - Florida Prepaid / 529 / Scholarship / Taxes CONFUSION!

Post by cshell2 »

My son started college this Fall as well and between scholarships and grants and the housing refunds for the late start and early shutdown (all are going home at Thanksgiving), I don't think we'll be able to use the AOTC for 2020 either.

But, I'm confused. Your son's tuition was only $1640/semester? Does the prepaid get applied all the time? Could your son take courses in the summer that you could get reimbursed with AOTC? Not going to help for 2020, but next year maybe.
SimonJester
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Re: DS First Semester @ College - Florida Prepaid / 529 / Scholarship / Taxes CONFUSION!

Post by SimonJester »

Take_Five wrote: Fri Nov 20, 2020 3:07 pm The final problem is in regards to the 529 & ESA accounts - maybe it's a good problem to have, but still a problem - I can take for the remaining $450 and up to the school's Cost of Attendance for food (equivalent to the 7-day meal plan cost.)

As I understand it you can take actual expenses upto the schools COA and you might need receipts in the event of an audit. This makes paying for every day food from the 529 problematic.


Next rolling the ESA into a 529 is allowed, however from what I have read if that 529 is then not going to be used for the intended recipient / previous FBO ESA child it becomes a grey area and most recommend you roll into a 529 owned by the child.
"They who can give up essential liberty to obtain a little temporary safety, deserve neither liberty nor safety." - Benjamin Franklin
DIFAR31
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Joined: Mon Jan 01, 2018 5:51 pm

Re: DS First Semester @ College - Florida Prepaid / 529 / Scholarship / Taxes CONFUSION!

Post by DIFAR31 »

Take_Five wrote: Fri Nov 20, 2020 3:07 pm Problem 2.) Part of DS' Scholarship becomes taxable due to Pre-paid plan. Because pre-paid gets applied to tuition first, the scholarship then covers Fees and then mostly the dorm room - which in my understanding makes this portion taxable? Do I have to claim this to pay the tax for or can I have my son file (still as a dependen)t and claim the scholarship (he has not had to file yet) to minimize the tax burden?
The scholarship was given to your son, so any part of the scholarship that was not used for tuition, fees and course-related expenses (required books, supplies, equipment, etc.) is taxable income reported on your son's tax return.

Problem 3.) Overfunded 529 accounts - I realize that I can transfer these accounts to a sibling...
The list of who you can transfer a 529 to is much bigger than simply the initial beneficiary's siblings.

I have read that you can withdraw penalty free an amount equal to the scholarship - but does that apply when part (a majority) of the scholarship is not being used for tuition (but R&B)?
Yes.

I have read that I need to send any withdrawal directly to DS - although I paid for the balance of $450 with my credit card? does that matter if I am still claiming him as a dependent or do I want to have him file to claim his scholarship as taxable and also report the 529 withdrawal?
Where did you read this? Generally, a 529 distribution can be made payable to the account owner (presumably you), the beneficiary, or the educational institution. I'm not personally familiar with pre-paid 529 plans, so maybe the rules there are different. Non-qualified distributions received by the beneficiary or school are taxable to the beneficiary; non-qualified distributions received by the account owner are taxable to the account owner.
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