@twoinanddone, all I’m saying is they’re not required to be prepared for every student (as per the IRS link I posted above), and that I have confirmed that my son’s school does not prepare them for students with taxable scholarships. I can’t answer for every university but it is definitely not true that a 1098-T is prepared for every student in the country. The purpose of the form is to ensure that students who may be entitled to a tax credit have documentation to support that; it is not intended as a form to report taxable scholarships. As far as I can find there is no form or specific process for educational institutions to report taxable scholarship income to the IRS, so taxpayers must keep track of things themselves to ensure they are paying what they owe. Some schools obviously do prepare 1098-T forms for everyone, but it is school-specific and one cannot assume that a form will be received.
Edit to add: for any student whose scholarship is worded specifically to cover “tuition and fees” (as my son’s will be) why would the school go to the trouble of preparing a 1098-T just to test? That would be extra unnecessary work for them. For piecemeal scholarships and grants that are awarded as dollar figures, yes I suppose they would have to add everything up to see if it sums up to tuition and fees. Otherwise, for scholarships like the big NMF packages or a full ride athletic scholarship there’s no need to add anything up because the school already knows tuition and fees are fully paid.
I just saying that most schools wouldn’t know whether they needed to provided the form, that scholarships didn’t exceed tuition and fees, unless they actually pulled the information and figure it out. For 2016, my daughter’s scholarships did not exceed her tuition and fees so the school did have to produce the 1098-T and did so online. This year, her scholarships did exceed the tuition and fees (because of studying abroad and the tuition not being paid to the school) so they didn’t HAVE to prepare the 1098-T, but they already had the information pulled and the form showed up again in the portal. No extra work for the school at all, the computer just put it online. It’s the exact same process whether the form is required to be completed and if it is not.
if they are required to claim the AOTC, and the student whose scholarships exceeded the tuition and fees wanted to declare extra scholarship money as taxable to claim the credit (as I’ve done with my other child) then not preparing the form hurts the student. If the school already has the info and it will get the family a tax credit, why can’t the school just throw it up online? I have two for two schools that do this.
It’s like employers who have a few employees who didn’t make enough to require a W-2 or a contractor who isn’t required to get a 1099-M. If the info is already in the payroll system, why not just issue those documents?
@twoinanddone, I don’t understand why there’s an argument…I am merely pointing out that per IRS rules schools do not have to prepare or file a 1098-T for every student. I also have a data point of a large state school in Texas that definitely does not do so. Upthread you claimed that the IRS definitely does get a 1098-T for every student, and that’s just not true. Sure there are logical arguments why schools SHOULD prepare 1098-T forms for everyone, but the fact is that they DON’T and for some students they aren’t legally required. So not everyone can assume they will receive a 1098-T, and should check the policy of their schools. For those that don’t expect to receive one, it’s even more important to keep careful records to make sure 529 distributions and taxable scholarships are correctly accounted for.
So what are the pros/cons to having 529 funds disbursed to the student beneficiary versus the school? If I’m reading this correctly:
To the student
Pros: EFT/ACH electronic banking/faster. Teaches student responsibility. 1099Q goes to student, so anything that is taxable is at the student’s rate.
Cons: Might have to prove QEE. Assumes student knows where the bursar’s office even is.
To the school
Pros: Cuts out the middleman. 1099Q goes to the student, so anything taxable is at the student rate. Less likelihood of needing to prove QEE?
Cons: Less flexibility with deadlines, because many schools don’t allow EFT/ACH directly from the fund manager. Checks = snail mail = charges for Fed Ex. Chance of schools changing financial aid based on 529 funds.
“Chance of schools changing financial aid based on 529 funds.”
The school already knows about the 529 funds as they are reported on FAFSA/CSS. I don’t think this is a possibility. I also don’t think the bursar’s office cares where the check comes from, they just post it.
Yes, it’s a possibility, and it has happened (by mistake). If the student is receiving need-based aid, the bursar’s office wants to know if checks coming in for a student’s benefit are coming from an outside scholarship that perhaps the school hasn’t been notified about. If they see a payment from a third party that they’re not familiar with, it wouldn’t be unheard of for them to mistakenly think that a check from a 529 administrator is actually from an outside scholarship, with the result being that there is a dollar-for-dollar reduction in institutional need-based aid.
In other words, the school might reduce the need-based aid (by mistake) not because they know there is money being used from a 529 plan, but because they think the check being posted is not from a 529, but from an outside scholarship.
If it happens, it should be easily correctable. Just keep a close eye on the billing statements.
@BelknapPoint – Question for you on your last sentence in this paragraph. (Years later here, and I still can’t quote properly with shading.)
“For most people who are eligible for education tax credits, it’s probably better to not pay all of the tuition and fees with 529 dollars, so that up to $2,500 in a tax credit can be claimed. In my opinion, foregoing a $2,500 tax credit is much worse than having an extra $4,000 in the 529 account at the end of the beneficiary’s undergraduate years. That money can always be repurposed, either by naming a new beneficiary, by using it for graduate school, or even using it for non-qualified purposes (in which case, by the way, the 10% additional tax would be waived due to claiming the tax credit)”
I agree completely with your reasoning about using non-529 monies to pay $4000 and then claim the AOTC, but if I disburse the unused $16K to myself after graduation, won’t I pay tax on the earnings plus the 10% penalty on the earnings portion of the $16K?
Alternatively, could I name my son as the owner and beneficiary of the account and have the unused funds disbursed to him and taxed at his lower rate? Could some of that money be disbursed to him each year? This might require setting up a new account in his name to hold the unused $16K and disbursing it before his graduation year since he will hopefully earn taxable income that year. Or am I completely messed up here?
No; the 10% additional tax can be waived in certain circumstances, including situations when 529 distributions are included in income because qualified education expenses were used for claiming a tax credit. See pg. 53 of IRS pub 970, Additional Tax on Taxable Distributions, exception #5.
I’m not sure what you’re asking here. A distribution, whether qualified or non-qualified, can always be made payable to the beneficiary, who is then responsible for any tax due.
I had no idea about the exception to the 10% penalty, so that is wonderful news.
My second question is poorly worded, at best. Something I had read made me think that I would need to transfer ownership of the 529 to my son in order to have non-qaulified distributions taxable at his rate. It sounds as though I can just skip that step and disburse unneeded funds to him and pay taxes at his rate.
Would IRS pub 970, Additional Tax on Taxable Distributions, exception #5 apply to him also, even though I would be the one who had claimed the AOTC throughout his college years?
Some great info in here, thanks. I see some are talking about using non-529 funds so that you can claim the $2500 American Opportunity Tax Credit. Agreed, easiest way is to not totally pay with the 529. But if not, I think after finding how to do this on the IRS site, this is right. Feel free to correct me.
Let’s say I have $70,000 qualified education expenses with all tuition, room and board, etc. If I pay the whole $70,000 out of a 529 plan and still claim the $2500 tax credit, that means $4000 (amount required to be paid to get $2500 credit) of that $70,000 was already taken, or $66,000 of qualified left. But let’s say only $2000 of that $70,000 was earnings in the 529 (box 2 of 1099-Q). That means 2000 x 66000/70000 is tax free earnings, or $1885. So taxable earnings is $2000 - $1885 = $115. Say I pay even total 29% federal and state taxes, .29 x 115 = $33 total extra tax.
Anyway, point was only the earnings part of 529 hasn’t been taxed yet, so that’s the only part that isn’t eligible for the tax credit. If you’ve had the 529 since the kid was born, earnings is probably much higher % of the total and it’d be much bigger tax. If not (or your stock investments crashed :D), extra tax is pretty small.
So make sure you actually qualify for the AOTC before deciding how to pay expenses.
Also for AOTC only tuition, qualified fees (not all fees are qualified fees, e.g. health fee and transportation fee are not), and books or required course supplies are QEE.
For 529 room and board and computer can also be QHEE.
So it would be best if you are eligible for AOTC to pay $66,000 out of 529 (remaining QHEE) and $4,000 (for tuition=QEE) out of pocket or with student loan/savings.
That is providing the student didn’t have any scholarships or grants paying for some of the same expenses.
Yeah, thanks, @mommdc that’s one thing I was realizing today is how it’s odd how there’s two types of qualified expenses - one for AOTC and different for 529 (or QTP I see), and that doing that calculation kind of co-mingles the two. Hadn’t seen them called QEE and QHEE, good to know. Guess you just have to make sure there’s enough without room and board to cover the AOTC part.
Yes, we had financial aid/scholarships last year, I didn’t include that for simplicity, but just wanted to verify how 529’s would affect AOTC. But if anyone wants to know how, the IRS publication shows how you just subtract that out first too. Good point on income limits - we’re well within those. We had some different savings other than 529’s, and now are looking at adding that for our younger son and even the one who’s already started.
I saw one state’s 529 that has some recapture fee if you take it out before 3 years from the start date. I don’t think that’s a general rule but if anyone knows something to the contrary would love to hear it. If we started for the one already in, would be taking it out much before that.
I hesitated in earlier years doing these 529’s because I didn’t know what our kids would be doing. Feel a bit like a bonehead that I didn’t research enough to learn that only the earnings portion gets the 10% penalty in case they didn’t do college and that you can take principal out tax free. Interesting though how you can’t JUST take out principal like a Roth IRA. Still, things have changed so much for us since they were born, not going to second guess myself.
@BelknapPoint, seriously? Good grief. Big thank you though for the idea of waiting to pay the last semester until that January so you can take the Lifetime Learning Credit!! I had to go back and reread your earlier post, thinking it made no sense since AOTC was only for 4 years. Then I got it, different credit. We’re a little ways from that still, but not sure I would’ve noticed that.
Can someone clarify this? I’ve read that if it turns out student gets a scholarship and doesn’t use or, at least, deplete 529 funds, student can withdraw without the 10% penalty (though must pay taxes on gains). Does this have to be done right away or can we wait until grad sch/career plans are finalized? I’m thinking leave the funds there (to grow) until certain that kid isn’t going to need them for more school. But if 10% penalty will be incurred later, I’d rather do withdrawal before knowing about grad sch. Hope that makes sense.