<p>We are at the phase out income level for getting the full AOC amount of $2500 (MAGI 168K). Do we still have to pay 4K in qualified expenses to generate our maximum allowed AOC or is it dollar for dollar for the first 2K? If we don’t have enough qualified expenses for 2014 AOC in one semester (starting freshman), should we prepay for the spring 2015 in December?</p>
<p>Thank you.</p>
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Yes, it’s up to you.</p>
<p>The tax credit is dollar for dollar for the first $2000 in expenses, then 25% for the remainder of the credit. The phase out works as a percentage, so you lose a percentage of the credit for which you are eligible. If you have scholarships that can be used for other expenses (such as room & board instead of tuition), those can be treated as taxable scholarships (taxable income to the STUDENT, not the parents), freeing up qualified expenses, or you can prepay spring tuition. The latter might be the better option, if you plan to do it all 4 years, because you can’t then use that tuition to qualify the following year, but over the course of a 4-year degree you might pay tuition during 5 tax years.</p>
<p>If you have $2000 in expenses, your potential credit is $2000, reduced by the phase out. If your expenses are $4000 your potential credit is $2500, reduced by the phase out. With a MAGI of 168k, you would be losing 40% of the credit, so $2000 in expenses would qualify for $1200 credit, and each $20 in expenses would gain you $3 additional credit, for a maximum of $1500 credit based on $4000 in expenses.</p>
<p>Remember also that any loans taken to pay qualified expenses count toward the credit too. And if you’re paying with money from a 529 account, you might still qualify as well.</p>
<p>So we still have to spend 4K to get the maximum. Thank you for the detailed explanation. I am new to this and trying to learn the ropes. I will have to find out about the merit scholarship he received, the letter does not say whether it is taxable and what it counts towards.
I am trying to strategize how much to pay from out of pocket and the rest will come from 529 plan. We have about 3K in tuition (after scholarship) and 2K in fees plus room in board for 2014/2015. We will pay all of the tuition and fees in 2014 to get AOC and pay for R+B from 529. I also heard that if we take 529 plan distribution made out to the student, and some of it ends up nonqualified, his tax rate is much lower. Does my plan make sense?</p>
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<p>My understanding is that nonqualified distributions are considered taxable income (the earnings portion of the nonqualified distribution only) for the person whose name and SSN were reported on the 1099-Q as having received the distribution. Since generally a child’s tax rate will be lower than that of the parent/s, it usually makes sense to have the distribution go to the student.</p>
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<p>Whether part of it is taxable will depend on whether it exceeds QEE: tuition, fees, required books and supplies(keep receipts). If the terms of the scholarship don’t state that it’s required to be applied to specific expenses, for tax purposes you can apply it to whatever expenses work out better for you and your student tax-wise.</p>
<p>IRS Pub 970 is the bible for all education tax topics:</p>
<p><a href=“http://www.irs.gov/pub/irs-pdf/p970.pdf”>http://www.irs.gov/pub/irs-pdf/p970.pdf</a></p>
<p>Regarding the 529 money, it is taxable to whomever takes the distribution. There is a semi-complicated calculation to figure out how much is taxable, explained in pub 970 (referenced above). If the scholarship is not restricted, I would pay $4000 of tuition in “cash” then use the scholarship, and pay everything else out of the 529. You can take more out of the 529 to pay non-qualified expenses, up to an amount equal to the scholarships - the earnings portion of that is what is taxable, as well as the scholarship used to pay non QEE (note that QEE for the scholarship is not the same as QEE for the 529). Pub 970 explains it well, but not necessarily in layman’s terms. </p>