AOTC & 529: Advice needed

[ra7]

Here is my situation.

my daughter started college last Fall. My AGI will qualify me to take advantage of the full AOTC credit. But I paid the tution and boarding expenses directly to college from 529. Now I am trying to see how to take advantage of AOTC for 2021.I have around 600$ that weren't paid from 529 (300$ enrollment fees, 100$ additional course fees, and 200$ books & expenses). Univ also gave a scholarship of $1500 which was paid in 2021. She also has unearned income of around $2700. 1099-Q shows the total distribution as $13,165.34, Earnings 5691.25, basis 7474.09. I am using H&R block software and it doesn't ask for any out of pocket expenses I paid. I also bought a laptop for her and I understand I shouldn't use AOTC for the laptop unless the college explicitly says it's required for the course. Anyway I can still take advantage of the full AOTC credit for 2021?. I should have paid out of pocket for the full AOTC amount, but by the time I realized about the credit it was too late. So going forward also what's the best way to pay the college directly or should I pay and request the check from my 529 plan?

[Pdxnative]

Find IRS Pub 970 and go to the section on Qualified Tuition plans. There’s a section in there explaining how to coordinate AOTC and 529 distribution.

[marcopolo]

Here is my situation.

my daughter started college last Fall. My AGI will qualify me to take advantage of the full AOTC credit. But I paid the tution and boarding expenses directly to college from 529. Now I am trying to see how to take advantage of AOTC for 2021.I have around 600$ that weren't paid from 529 (300$ enrollment fees, 100$ additional course fees, and 200$ books & expenses). Univ also gave a scholarship of $1500 which was paid in 2021. She also has unearned income of around $2700. 1099-Q shows the total distribution as $13,165.34, Earnings 5691.25, basis 7474.09. I am using H&R block software and it doesn't ask for any out of pocket expenses I paid. I also bought a laptop for her and I understand I shouldn't use AOTC for the laptop unless the college explicitly says it's required for the course. Anyway I can still take advantage of the full AOTC credit for 2021?. I should have paid out of pocket for the full AOTC amount, but by the time I realized about the credit it was too late. So going forward also what's the best way to pay the college directly or should I pay and request the check from my 529 plan?

A couple of points.

1) Expenses that qualify for AOTC is a subset of those that qualify for 529 withdrawals. Add up all your 529 qualified expenses. Subtract that from what you withdrew from 529 funds. All of that can be used to qualify for AOTC because you can attribute the first $4k of tuition to AOTC, and the rest qualifies for 529. The fact that you actually used 529 to pay for tuition does not preclude you from allocating it this way.

2) If that difference is less than $4000, you can still claim the full AOTC, you just have to pay taxes (but no 10% penalty) on the earnings associated with the amount the difference. As an example, lets say you the $600 in expenses as you described, and the computer was $1400. So, you would have $2k in expenses that qualify for 529 beyond what you withdrew. That $2k can be used for AOTC. The other $2k of the 529 withdrawal that you use for AOTC would get taxed proportionally. Since approximately 43% of the withdrawals were earning, you would add about $860 to your daughters unearned income. Depending on what other income she has, there may actually be little or no taxes due for that. EDIT: I see she had some unearned income above the kiddie tax threshold, so she will owe taxes on that $860 (in this example) at your marginal rate. Still worth capturing the AOTC tax credits.

We always found it best to have the 529 send the money to our kids and have them pay for qualified expenses.

[anita bahth]

Anyway I can still take advantage of the full AOTC credit for 2021?. I should have paid out of pocket for the full AOTC amount, but by the time I realized about the credit it was too late. So going forward also what's the best way to pay the college directly or should I pay and request the check from my 529 plan?

Yes, as long as your tuition bill was more than 4k you are fine, even if paid by the 529. TT handles this seamlessly, so I wonder why HRB is causing confusion. Basically, some part of the 4k will be considered income and taxed (form 5329 part II should be filled in), but there's no addl 10% penalty.

Going forward, it just depends how much you have in the 529. If it's way too much, then doing the same as last year at least lets you take out the money w/o penalty. If it's going to run out anyway, then pay the 4k out of pocket and leave the 4k in the 529 for next year.

[Admiral Fun]

2) If that difference is less than $4000, you can still claim the full AOTC, you just have to pay taxes (but no 10% penalty) on the earnings associated with the amount the difference. As an example, lets say you the $600 in expenses as you described, and the computer was $1400. So, you would have $2k in expenses that qualify for 529 beyond what you withdrew. That $2k can be used for AOTC. The other $2k of the 529 withdrawal that you use for AOTC would get taxed proportionally. Since approximately 43% of the withdrawals were earning, you would add about $860 to your daughters unearned income. Depending on what other income she has, there may actually be little or no taxes due for that. EDIT: I see she had some unearned income above the kiddie tax threshold, so she will owe taxes on that $860 (in this example) at your marginal rate. Still worth capturing the AOTC tax credits.

We always found it best to have the 529 send the money to our kids and have them pay for qualified expenses.

I'd like to claim the AOTC and pay with the 529 at the same time.

Let's say I want to limit our kid's unearned income to no more than $1150 so that they don't need to file their own tax return.

Can I send $2738 (or a little less) of 529 money to kid, and then the remainder to us? At 42% earnings, that would give our kid exactly $1150 unearned income (at 0% tax).

Does this work how I think it works?

[marcopolo]

2) If that difference is less than $4000, you can still claim the full AOTC, you just have to pay taxes (but no 10% penalty) on the earnings associated with the amount the difference. As an example, lets say you the $600 in expenses as you described, and the computer was $1400. So, you would have $2k in expenses that qualify for 529 beyond what you withdrew. That $2k can be used for AOTC. The other $2k of the 529 withdrawal that you use for AOTC would get taxed proportionally. Since approximately 43% of the withdrawals were earning, you would add about $860 to your daughters unearned income. Depending on what other income she has, there may actually be little or no taxes due for that. EDIT: I see she had some unearned income above the kiddie tax threshold, so she will owe taxes on that $860 (in this example) at your marginal rate. Still worth capturing the AOTC tax credits.

We always found it best to have the 529 send the money to our kids and have them pay for qualified expenses.

I'd like to claim the AOTC and pay with the 529 at the same time.

Let's say I want to limit our kid's unearned income to no more than $1150 so that they don't need to file their own tax return.

Can I send $2738 (or a little less) of 529 money to kid, and then the remainder to us? At 42% earnings, that would give our kid exactly $1150 unearned income (at 0% tax).

Does this work how I think it works?

You are wanting the $2738 distributed to your kid to be part of the $4000 that is allocated to both qualified expenses and AOTC? such that only 42% of the $1262 used for both would be taxable to you?

I don't think you can do that as far as I am aware. I don't believe that the AOTC can be split like that. I think it all has to be claimed by either the parent or the student.

[teen persuasion]

2) If that difference is less than $4000, you can still claim the full AOTC, you just have to pay taxes (but no 10% penalty) on the earnings associated with the amount the difference. As an example, lets say you the $600 in expenses as you described, and the computer was $1400. So, you would have $2k in expenses that qualify for 529 beyond what you withdrew. That $2k can be used for AOTC. The other $2k of the 529 withdrawal that you use for AOTC would get taxed proportionally. Since approximately 43% of the withdrawals were earning, you would add about $860 to your daughters unearned income. Depending on what other income she has, there may actually be little or no taxes due for that. EDIT: I see she had some unearned income above the kiddie tax threshold, so she will owe taxes on that $860 (in this example) at your marginal rate. Still worth capturing the AOTC tax credits.

We always found it best to have the 529 send the money to our kids and have them pay for qualified expenses.

I'd like to claim the AOTC and pay with the 529 at the same time.

Let's say I want to limit our kid's unearned income to no more than $1150 so that they don't need to file their own tax return.

Can I send $2738 (or a little less) of 529 money to kid, and then the remainder to us? At 42% earnings, that would give our kid exactly $1150 unearned income (at 0% tax).

Does this work how I think it works?

You are wanting the $2738 distributed to your kid to be part of the $4000 that is allocated to both qualified expenses and AOTC? such that only 42% of the $1262 used for both would be taxable to you?

I don't think you can do that as far as I am aware. I don't believe that the AOTC can be split like that. I think it all has to be claimed by either the parent or the student.

I don't think who pays (student or parents) matters, but yes only one return will claim the AOTC - parents if student is a dependent, student if not a dependent.

I haven't used 529s, but we have had our children claim part (additional $4k) of their scholarships as taxable income so that we (parents) could claim the AOTC. If the child incurred any additional tax (usually no federal, but definitely state) we paid their tax bill since we benefitted from AOTC. If the tax cost outweighed the credit, we would just not bother.

We did have issues using the above method (which is recommended in the IRS instructions) with our DS4 (but not his 3 older siblings) on our state tax return. A few years after filing the returns, the state said we were not eligible for the state tuition credit, based on his 1098T and our return. Of course - they could not see the taxable scholarships on HIS return, and the state forms dropped the SCH designation that is on the federal 1040 that called it out as non-wage income. Had to submit calculations and his federal return to clarify things, ultimately for 3 different years.

[Admiral Fun]

You are wanting the $2738 distributed to your kid to be part of the $4000 that is allocated to both qualified expenses and AOTC? such that only 42% of the $1262 used for both would be taxable to you?

I don't think you can do that as far as I am aware. I don't believe that the AOTC can be split like that. I think it all has to be claimed by either the parent or the student.

Thanks, still trying to figure out how this works. Let's say I allocated $4000 to my student and additional $4000 to me (the parent). Come tax time, can I choose who pays the taxes on the $ that is both qualified expenses and AOTC? (as long as it is not split)

[marcopolo]

You are wanting the $2738 distributed to your kid to be part of the $4000 that is allocated to both qualified expenses and AOTC? such that only 42% of the $1262 used for both would be taxable to you?

I don't think you can do that as far as I am aware. I don't believe that the AOTC can be split like that. I think it all has to be claimed by either the parent or the student.

Thanks, still trying to figure out how this works. Let's say I allocated $4000 to my student and additional $4000 to me (the parent). Come tax time, can I choose who pays the taxes on the $ that is both qualified expenses and AOTC? (as long as it is not split)

It gets a little complicated.

If the student is not your dependent, then only they can claim the full refundable and non-refundable portion of the credit.

If the student is your dependent and you claim them as such, then only you can claim the full refundable and non-refundable portion of the credit.

If the student is your dependent, but you don't claim them as such, then only they can claim just the refundable portion of the tax credit, meaning they have to have enough tax liability to be offset the credit.

[Katietsu]

You are wanting the $2738 distributed to your kid to be part of the $4000 that is allocated to both qualified expenses and AOTC? such that only 42% of the $1262 used for both would be taxable to you?

I don't think you can do that as far as I am aware. I don't believe that the AOTC can be split like that. I think it all has to be claimed by either the parent or the student.

Thanks, still trying to figure out how this works. Let's say I allocated $4000 to my student and additional $4000 to me (the parent). Come tax time, can I choose who pays the taxes on the $ that is both qualified expenses and AOTC? (as long as it is not split)

I am not aware of any restrictions on which person includes QTP earnings on their tax return if both have 1099-Q income. Most of the responses seem to be focused on the Form 8863 and the AOTC credit not the QTP income. Usually it would be best from a tax prospective to keep the 1099-Q in the student’s name when they have no other income. In your example, federal taxes would be just [(4000*.42)-1150]*.10 which I think is just $53. However, I understand that there may be other considerations.

[Pdxnative]

You are wanting the $2738 distributed to your kid to be part of the $4000 that is allocated to both qualified expenses and AOTC? such that only 42% of the $1262 used for both would be taxable to you?

I don't think you can do that as far as I am aware. I don't believe that the AOTC can be split like that. I think it all has to be claimed by either the parent or the student.

Thanks, still trying to figure out how this works. Let's say I allocated $4000 to my student and additional $4000 to me (the parent). Come tax time, can I choose who pays the taxes on the $ that is both qualified expenses and AOTC? (as long as it is not split)

I am not aware of any restrictions on which person includes QTP earnings on their tax return if both have 1099-Q income. Most of the responses seem to be focused on the Form 8863 and the AOTC credit not the QTP income. Usually it would be best from a tax prospective to keep the 1099-Q in the student’s name when they have no other income. In your example, federal taxes would be just [(4000*.42)-1150]*.10 which I think is just $53. However, I understand that there may be other considerations.

This was my thought also. Simple approach is to take the AOTC on the parent return, push the taxable portion of 529 distribution to kid return to get the standard deduction plus low tax rate. If there’s some reason not to take the full AOTC due to kiddie tax or something, just do the math at tax time and choose the optimal path.

Remember with the AOTC you’re getting 100% of the first 2k and 25% of the next 2k. So you can get the majority of the credit by making the earnings portion of ~2k of the 529 distribution taxable, which it sounds like would accomplish your goal. You can do the math on how much of the next ~2k you can use to stay under the filing threshold if that’s your goal.

[marcopolo]

You are wanting the $2738 distributed to your kid to be part of the $4000 that is allocated to both qualified expenses and AOTC? such that only 42% of the $1262 used for both would be taxable to you?

I don't think you can do that as far as I am aware. I don't believe that the AOTC can be split like that. I think it all has to be claimed by either the parent or the student.

Thanks, still trying to figure out how this works. Let's say I allocated $4000 to my student and additional $4000 to me (the parent). Come tax time, can I choose who pays the taxes on the $ that is both qualified expenses and AOTC? (as long as it is not split)

I am not aware of any restrictions on which person includes QTP earnings on their tax return if both have 1099-Q income. Most of the responses seem to be focused on the Form 8863 and the AOTC credit not the QTP income. Usually it would be best from a tax prospective to keep the 1099-Q in the student’s name when they have no other income. In your example, federal taxes would be just [(4000*.42)-1150]*.10 which I think is just $53. However, I understand that there may be other considerations.

This was my thought also. Simple approach is to take the AOTC on the parent return, push the taxable portion of 529 distribution to kid return to get the standard deduction plus low tax rate. If there’s some reason not to take the full AOTC due to kiddie tax or something, just do the math at tax time and choose the optimal path.

Remember with the AOTC you’re getting 100% of the first 2k and 25% of the next 2k. So you can get the majority of the credit by making the earnings portion of ~2k of the 529 distribution taxable, which it sounds like would accomplish your goal. You can do the math on how much of the next ~2k you can use to stay under the filing threshold if that’s your goal.

I think if you do that, the taxable portion on kids return would also be subject to the 10% penalty. I am not sure the exception to the penalty can be used across returns.

[Pdxnative]

You are wanting the $2738 distributed to your kid to be part of the $4000 that is allocated to both qualified expenses and AOTC? such that only 42% of the $1262 used for both would be taxable to you?

I don't think you can do that as far as I am aware. I don't believe that the AOTC can be split like that. I think it all has to be claimed by either the parent or the student.

Thanks, still trying to figure out how this works. Let's say I allocated $4000 to my student and additional $4000 to me (the parent). Come tax time, can I choose who pays the taxes on the $ that is both qualified expenses and AOTC? (as long as it is not split)

I am not aware of any restrictions on which person includes QTP earnings on their tax return if both have 1099-Q income. Most of the responses seem to be focused on the Form 8863 and the AOTC credit not the QTP income. Usually it would be best from a tax prospective to keep the 1099-Q in the student’s name when they have no other income. In your example, federal taxes would be just [(4000*.42)-1150]*.10 which I think is just $53. However, I understand that there may be other considerations.

This was my thought also. Simple approach is to take the AOTC on the parent return, push the taxable portion of 529 distribution to kid return to get the standard deduction plus low tax rate. If there’s some reason not to take the full AOTC due to kiddie tax or something, just do the math at tax time and choose the optimal path.

Remember with the AOTC you’re getting 100% of the first 2k and 25% of the next 2k. So you can get the majority of the credit by making the earnings portion of ~2k of the 529 distribution taxable, which it sounds like would accomplish your goal. You can do the math on how much of the next ~2k you can use to stay under the filing threshold if that’s your goal.

I think if you do that, the taxable portion on kids return would also be subject to the 10% penalty. I am not sure the exception to the penalty can be used across returns.

Pretty sure this fits within the exception. Even Pub 970 uses the example of a dependent beneficiary reporting income because parents took the AOTC, then refers back to that example after describing the exception to the 10% tax when the income was a result of coordination. I think the important thing for the AOTC is that there is no overlap of benefits.

[marcopolo]

Thanks, still trying to figure out how this works. Let's say I allocated $4000 to my student and additional $4000 to me (the parent). Come tax time, can I choose who pays the taxes on the $ that is both qualified expenses and AOTC? (as long as it is not split)

I am not aware of any restrictions on which person includes QTP earnings on their tax return if both have 1099-Q income. Most of the responses seem to be focused on the Form 8863 and the AOTC credit not the QTP income. Usually it would be best from a tax prospective to keep the 1099-Q in the student’s name when they have no other income. In your example, federal taxes would be just [(4000*.42)-1150]*.10 which I think is just $53. However, I understand that there may be other considerations.

This was my thought also. Simple approach is to take the AOTC on the parent return, push the taxable portion of 529 distribution to kid return to get the standard deduction plus low tax rate. If there’s some reason not to take the full AOTC due to kiddie tax or something, just do the math at tax time and choose the optimal path.

Remember with the AOTC you’re getting 100% of the first 2k and 25% of the next 2k. So you can get the majority of the credit by making the earnings portion of ~2k of the 529 distribution taxable, which it sounds like would accomplish your goal. You can do the math on how much of the next ~2k you can use to stay under the filing threshold if that’s your goal.

I think if you do that, the taxable portion on kids return would also be subject to the 10% penalty. I am not sure the exception to the penalty can be used across returns.

Pretty sure this fits within the exception. Even Pub 970 uses the example of a dependent beneficiary reporting income because parents took the AOTC, then refers back to that example after describing the exception to the 10% tax when the income was a result of coordination. I think the important thing for the AOTC is that there is no overlap of benefits.

It appears you are correct. I had always kept them on the same tax return. But, that is clearly not necessary.
Thanks for the reference.

[thedaybeforetoday]

Here is my situation.

my daughter started college last Fall. My AGI will qualify me to take advantage of the full AOTC credit. But I paid the tution and boarding expenses directly to college from 529. Now I am trying to see how to take advantage of AOTC for 2021.I have around 600$ that weren't paid from 529 (300$ enrollment fees, 100$ additional course fees, and 200$ books & expenses). Univ also gave a scholarship of $1500 which was paid in 2021. She also has unearned income of around $2700. 1099-Q shows the total distribution as $13,165.34, Earnings 5691.25, basis 7474.09. I am using H&R block software and it doesn't ask for any out of pocket expenses I paid. I also bought a laptop for her and I understand I shouldn't use AOTC for the laptop unless the college explicitly says it's required for the course. Anyway I can still take advantage of the full AOTC credit for 2021?. I should have paid out of pocket for the full AOTC amount, but by the time I realized about the credit it was too late. So going forward also what's the best way to pay the college directly or should I pay and request the check from my 529 plan?

We have/had 3 kids in college at the moment and have always paid the Universities directly and received check from the 529.

[Katietsu]

We have/had 3 kids in college at the moment and have always paid the Universities directly and received check from the 529.

Just remember that in the situation being discussed here, it matters if the 1099-Q is issued in the parent or the child name. The name on the check will dictate the numbers on the 1098. Payments directly from the 529 to the school will show up on child’s 1099.

Having the payment go directly from the 529 to the school has always seemed cleaner and also avoids people making the payments and withdrawals in different years. But it can be handled either way.