529 and American Opp. Credit - how use both?

[JV]

Hi, Fellow BHs. Could use a hand with a confusing tax issue. In a nutshell, here's my situation.

MFJ, 2 kids in college FT (living at home) claimed as dependents and 529 beneficiaries, but I am the 529 account holder. All withdrawals from the 529 go directly to my bank acct. and I pay tuition from there. In prior years DW and I never qualified for the American Opp. Credit (AOC) so I had minimal trouble matching 529 withdrawal and college expenses (thus eliminating tax issues). In 2023 I maxed DW's 403b and we now qualify for a partial AOC credit per kid of $802, or $1604 total. In 2023 I paid all college expenses with the 529s, so I am double-dipping if I take the AOC.

Questions:
- I need to add to my tax return that I over-withdrew from the 529, and I know only earnings are taxed, but do I simply use the total cost of the credit ($1604) as the basis for that?

- If the above is the case, when I calculate taxable earnings on that $1604, the AOC drops from $802 to $750 per kid, probably because my taxable earnings increased. So this is like jello: every time I amend the earnings amount, the AOC changes.

- Last question is whose tax return does the taxable earnings need to be added to? I've been researching/web-searching this topic and experimenting with the tax software and things don't jive. Being the account owner, I figured I'd need to pay the tax on that excess 529 earnings portion, but H&R Block software clearly says the beneficiary must pay the tax on that excess withdrawal. Web searches indicate the account owner should pay it, but again, the software doesn't give that option.

Honestly feel the AOC is just not worth it since I fully funded their tuition via the 529s and I'm about to give up. The IRS can't make this more difficult.

[JV]

Hate doing this, but bumping to take the chance that someone can assist.

[Irene]

Will you also be paying tuition this year? If so you may be able to count some of that 529 withdrawal as going toward this year's tuition rather than last (i.e., pay cash for some of the tuition this year, as you would have done last year if you had thought of it in time). It is supposed to match up from year to year, but as the academic year crosses the calendar years, mismatches are very frequent. If it all tallies at the end I would not expect there to be a problem. I am pretty sure I did that very thing the first or second year we were paying college tuition.

The other option is just not to take the AOC, which would be a pity to miss, but doesn't sound as though it would be an actual hardship.

[bridgetek]

I’ve had similar issues. This is the best reference I found to figure out how AOTC and 529 distributions interact.
https://www.savingforcollege.com/articl ... tax-return

For example, suppose a student paid $5000 for tuition and another $5000 for room and board. Both are qualified 529 expenses, so you withdrew $10,000 from the 529 for that child. No taxes due.

If you are below the AGI limits, you can apply up to $4000 tuition to AOTC and earn up to a $2500 tax credit. If your AGI is near the limit, you might be eligible for a presentage of the 2500.maximum.

If you use $4000 tuition for AOTC, you cannot also use 529 to pay for that 4000. So your adjusted qualified education expenses is reduced from $10,000 to $6000. So now you need to pay taxes on the earnings part of that $4000 that is no longer a qualified 529 distribution. But, fortunately you don’t have to pay the 10% penalty.

I always take the credit and pay any taxes on our tax return, because my kid doesn’t file taxes. So I don’t know how it works on the child tax returns.

I hope that helps. I’m definitely not a tax expert, just another parent trying to survive the college years. Good luck!

[JV]

I’ve had similar issues. This is the best reference I found to figure out how AOTC and 529 distributions interact.
https://www.savingforcollege.com/articl ... tax-return

For example, suppose a student paid $5000 for tuition and another $5000 for room and board. Both are qualified 529 expenses, so you withdrew $10,000 from the 529 for that child. No taxes due.

If you are below the AGI limits, you can apply up to $4000 tuition to AOTC and earn up to a $2500 tax credit. If your AGI is near the limit, you might be eligible for a presentage of the 2500.maximum.

If you use $4000 tuition for AOTC, you cannot also use 529 to pay for that 4000. So your adjusted qualified education expenses is reduced from $10,000 to $6000. So now you need to pay taxes on the earnings part of that $4000 that is no longer a qualified 529 distribution. But, fortunately you don’t have to pay the 10% penalty.

I always take the credit and pay any taxes on our tax return, because my kid doesn’t file taxes. So I don’t know how it works on the child tax returns.

I hope that helps. I’m definitely not a tax expert, just another parent trying to survive the college years. Good luck!

Thanks for your response. What I don't understand is how much I need to claim as the overpayment on the 529. Is it the earnings on the $1604 total credit, or is it the earnings on $4000, and if so, is that per child? The $4000 doesn't make sense, since if I claim that, the AOC effectively gets wiped away, so why bother claiming it at all?

[Irene]

Assuming the $802 is based on claiming $4000 in tuition paid, but is reduced from $2500 due to your MAGI being over a certain level, then you would have to pay the tax and penalty on the earnings portion of a 529 withdrawal of $4000 ($8000 for both students). If that does away with the benefit of the AOC, there's no point in claiming it, as you say.

[bongo]

In prior years DW and I never qualified for the American Opp. Credit (AOC) so I had minimal trouble matching 529 withdrawal and college expenses (thus eliminating tax issues).

Did your kids have earnings/pay taxes in those years? They might have been able to claim AOTC instead of you. It might be a bit of hassle now to amend those years (and you can't claim them as dependents), but it could be worth $2500 each minus their tax on the earnings part of the non-qual 529 withdrawal minus the $500 you got for the other dependent credit. If not worth amending, at least you could see if it works this year.

If they didn't have any income in 2024, then the best you could do is claim the AOTC yourself. The amount of the non-qual withdrawal earnings is added as income. [I always had the 529 checks made out to my kid, so the 1099-Q had their SS on it and they claimed the income on their taxes - but if the 1099-Q has your SS on it, I think you are still allowed to have them claim the income...but you should double-check that.] So say your $4k non-qual withdrawal was 1/2 earnings. That would be $2k unearned income on your kid's taxes. The first $1300 is taxed at 0% and the next $700 at 10% for a total tax of $70. You'd have to check state taxes too.

[986racer]

You may want to check this thread on how to use both : Back Door AOTC