AOTC for 4 years and LLTC for 1 year?

My son is going into his senior year of college. I have used the American Oportunity Tax Credit (AOTC) for 3 years so far. I understand that I can only use it for a maximum of 4 tax years. I believe we have discussed in the past on this forum the possibility of doing AOTC for 4 years and doing the Lifetime Learning Tax Credit (LLTC) for 1 year since the typical 4-years of college actually spans 5 tax years. I was very close to the income limit of not being able to use LLTC, but 2020 with all the craziness may be presenting an opportunity with less income. I may try to use the LLTC for 2020 and then the AOTC in 2021 for my son’s last semester of college. As I wasn’t expecting to be able to do this due to income limitations, I really have not paid attentions to the rules concerning it. In a brief search, I don’t think there are any problems. Just wondering if there are any gotchas from the experienced members on this board of such a plan.

Thanks

No gotchas as long as the rules for each credit are followed. I did something similar with one of my kids – AOTC in fall freshman year, spring freshman year and spring sophomore year, LLC in spring junior year, and then she took the last year of AOTC on her tax return (she was no longer claimed as a tax dependent on my return) in spring senior year. It worked out better for her to take the partially refundable AOTC instead of the non-refundable LLC on her return when she was no longer claimed as my tax dependent.

Thanks. The next thought in my head is should I do it? I have one more child to put through college who won’t start for another couple of years. In other words, I have no idea how much the college will cost. I therefore am not sure how much to eat into my 529 balance now. To max the LLC (or is LLTC??), I need to spend $10K out of pocket. That would be $10K I had been planning to withdraw from my 529. It’s not a huge deal if I am left with some money in my 529 when all kids done with college(no problem helping to pay with grad school with whatever is left over, saving it for a grandchild or perhaps even making an unqualified withdrawal down road). The bigger potential issue, however, is the spending $10K out of pocket now. It was $10K that was really not planned and although possible, may make things a bit tougher this year. I am not asking to comment on my financial ability to pay it, but rather how valuable is the LLC? To me the AOTC is really worth it - putting up $4K to get back $2.5K is a great deal. In the LLC case, putting up $10K to get $2K still sounds pretty good, but when I add in the possibility of ending up with an extra $10K in my 529, I start to have doubts.

The AOTC is definitely easier to take and more valuable. However, with five tax years and only four years of AOTC to use, working in the LLC if possible should be considered. One thing you can think about is using for the LLC $10k what would otherwise be nontaxable money (scholarships, grants, etc., maybe even 529 money) and declaring it as taxable so that the double dipping problem goes away. You would need to run the different scenarios through estimated tax returns to see what the financial plusses and minuses are.

Your income in future years , including this year and next , can be a limiting factor in using the tax credits, particularly for your next student. It seems to me, taking the benefit of these tax credits while you can is a good idea

If the problem is coming up with $10k now, look into the costs of borrowing it through PLUS. You can then repay the loan with the 529 money which is now allowed.

Hmmm…interesting ideas.

For cptofthhouse’s suggestion, let me make sure I understand:

  1. Take out a $10K (ie., PLUS) in 2020
  2. Pay school bill with loan in 2020
  3. Come tax time for 2020, take the LLC credit.
  4. Use 529 money to repay the loan as soon as I can. Immediately?

Is that allowed?

For BelknapPoint’s suggestions, making scholarships, grants, etc., or 529 money taxable, would they be taxable on my son’s return (he does get a grant and is a dependent on my tax return)? Actually, I assume as the owner of the 529 plan, that one would have to be my return.

For repaying a PLUS loan taken out by the parent of a dependent undergraduate student, I don’t think so. From the definitions of 529 Qualified Higher Education Expenses in IRS Pub 970:

For distributions made from QTPs after 2018, no more than $10,000 paid as principal or interest on qualified student loans of the designated beneficiary or the designated beneficiary’s sibling.

I wouldn’t classify a PLUS loan taken out by the parent of a dependent undergraduate student as a student loan “of the designated beneficiary.”

Scholarships and grants, yes. The tax (and any applicable penalty) owed on the earnings portion of a non-qualified 529 distribution is attributed depending on how the distribution was made. If the distribution was made payable to the student/beneficiary or the school, the earnings are reported on the student’s tax return. If the non-qualified distribution was made payable to the account owner, the earnings are reported on the account owner’s tax return.

I understand the point. Alternatively, a loan to the student (direct subsidized or unsubsidized loan) would qualify. That could be an option as I don’t use the unsubsidized loans, but the $10K limit is a bit of an issue as I was hoping to use the 529 to repay his subsidized loans. In addition, wouldn’t have $10K of unsubsidized loans this year. So, probably wouldn’t do this option.

This is a bit confusing. For example, if I make the distribution to my son, I can certainly put it on his taxes. I believe this would avoid the 10% penalty but would pay taxes on the gains at my son’s rates. That part is clear. But then where is the LLC claimed (his return or mine)? 529’s also have potential recapture rules with the state, which is another element if it applies. Although this is a possibility, it seems a bit more confusing.

This seems like a good option. I guess I have the same question for which return would use the LLC if I report a grant as taxable on my son’s return. Another question is whether one can claim part of a grant as taxable. For example, if my son got $20K in grants but I want to make $10K taxable to max out the LLC, is that possible.

Looks like I have some homework to do.

A taxable grant or scholarship awarded to your son is only reported on his (the student’s) tax return. It doesn’t matter whether the taxability is an option (for instance, the grant is used to pay tuition and a choice is made to pay tax on it to take advantage of a different tax benefit and avoid double dipping) or not (grants and scholarships used to pay for non-qualified expenses like room and board). If you actually claim your son as a tax dependent on your return, only you can claim the LLC for his qualified education expenses. If your son is not claimed as a tax dependent on someone else’s return, even if he could be, then he can claim the LLC on his tax return for his qualified education expenses.

Yes, this is possible.

If you haven’t already done so, I suggest you start by going through the relevant sections of IRS Pub 970.

https://www.irs.gov/pub/irs-pdf/p970.pdf

The only way to avoid the 10% penalty on non-qualified 529 distributions is for one of the exceptions to apply, and the exceptions are not dependent on who the non-qualified distribution is made payable to, unless the beneficiary is deceased. Also, the penalty is assessed after deductions and non-refundable credits are applied, meaning that the only way to offset it is through pre-filing payments (payroll withholding or quarterly estimated payments, etc.) or refundable credits.

Parent PLUS loans also have a large origination fee. You may not recover that in a tax credit.

Just to be clear here, one of the exceptions to the 10% penalty is a distribution because qualified education expenses were used to determine the AOTC or LLC credits. So, perhaps this a decent option.

I am starting to think that a combination of the options here may be best.

  1. I played around in Turbotax to see how making a grant taxable would work. There may be another way, but the only option I saw to do that was to say the grant was used for food/housing. Still looking at that, but in his case it seemed about $2K hardly affected his taxes. More than that and state taxes kicked in and eventually more federal taxes kicked in.
  2. Assuming my son does not get any Federal subsidized loans this year (he didn’t last year), I still can use another $2K of unsubsidized loans and be under that $10K max to pay back with 529 money. So, I think my son can accept $2K of unsubsidized loans (fee 1%) and pay it back right away from the 529.
  3. Maybe even do some as an unqualified withdrawal from the 529. The main wrinkle here is the cost basis of the 529 to determine earnings. My son has a Coverdell IRA that I have been withdrawing from every year and putting that money into his 529. Even though a NY 529 rep told me it resets the cost basis doing that, I never really believed that. However, I never really kept good records about the cost basis. Assuming I only take qualified withdrawals (that was my plan), it wasn’t a big deal. Well, now it may be an issue.
  4. I may be able to just pay a bit out of pocket.

Perhaps alot of work to save a few bucks here. At the very least, the options are all interesting.

The beneficiary of a 529 plan is typically the student, but the account owner can change the beneficiary to be a parent. This could be helpful in the case of those who took out Parent PLUS loans to pay for their child’s college education, allowing them to use 529 money to repay the loans.

Update: Now that we got all our W2s/1099G, I was able to figure out how I would do this. My goal was to have $10K out of pocket expenses to use the LLC credit. I actually paid around $7K out of pocket last year. To get to the remaining $3K, I made $3K of his grant taxable.

Some follow-on questions/comments:

  1. For anyone who has declared part of their grant taxable and use Turbotax, how did you do it? The only way I see is to say some of the grant was used for room and board. I guess that works, but was wondering if there was a way to just say it is taxable.

  2. My son only had $300 of income last year. Reporting the $3K on my son’s taxes did not cause him to have any Federal taxes. It did cause a small amount of state taxes. So, state taxes is something to look out for.

  3. Just curious: If my son had no other income and no taxes due after declaring some of his grant as taxable, would he need to file a tax-return?

  4. This strategy of making grants/scholarships taxable, I believe, can also be used to use up more 529 money in a given year. Depending on the income of the child, you can declare part of a grant/scholarship taxable and not have any extra taxes due on the child’s return. By doing that, you have made more tuition available to use for 529 purposes. I’m surprised I haven’t heard more people discuss it. I guess the big qualifier is the son’s other income. Many times they have some.

I realize some of the questions above are tax questions and this is not a tax board. One should never rely solely on info on a web board for anything.

Thanks

Is it clear that a Parent PLUS loan is a “qualified student loan” of the designated 529 beneficiary, as required according to IRS Pub 970? I’m not so sure. The actual beneficiary of a Parent PLUS loan is not the parent who has taken out and is responsible for repaying the loan; it is the student whose college expenses the loan proceeds were used to pay.