Quick 529 question

Paying for College
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<p>Okay, so this is where we stand.</p>

<p>1) Based on Savingforcollege.com: “Disregard the taxable scholarship income in computing your 529-eligible expenses. Room and board does not have to be reduced for this.”</p>

<p>and</p>

<p>2) The exact opposite: That I can only claim an 529 QEE after I reduce the QEE by the amount of the taxable scholarships.</p>

<p>Based on the fact that the IRS allows you to ignore the scholarships when determining QEE for AOC as long a) you are willing to report as income and pay taxes on it and b) you use no other tax advantage dollar to pay the AOC QEE then 1) makes sense assuming that the IRS follows the same rules for 529s. However the IRS is not always consistent which is why I started this conversion.</p>

<p>Also from Pub 970:</p>

<p>"To determine if total distributions for the year are more or less than the amount of qualified education expenses, you must compare the total of all QTP distributions for the tax year to the adjusted qualified education expenses.</p>

<p>Adjusted qualified education expenses.</p>

<p>This amount is the total qualified education expenses reduced by any tax-free educational assistance. Tax-free educational assistance includes:</p>

<p>The tax-free part of scholarships and fellowships (see TaxFree Scholarships and Fellowships in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions),
Veterans’ educational assistance (see Veterans’ Benefits in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions),
Pell grants (see Pell Grants and Other Title IV NeedBased Education Grants in chapter 1, Scholarships, Fellowships, Grants, and Tuition Reductions),
Employer-provided educational assistance (see chapter 11, EmployerProvided Educational Assistance), and
Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assis-tance."</p>

<p>Note there does not seem to be any mention of taxable scholarships.</p>

<p>People seem stuck on the fact that no dollars are physically being paid out of my bank account. This would also be true of students who live at home and have a full scholarship and no other QEE but declared part of the scholarship taxable so the parent can claim the AOC. No money is paid by either the student (except taxes) or the parent yet they get the AOC. Is that only allowed if you have other expenses that qualify under the 529 rules but not the AOC rules? Is that the critical piece that I missed? </p>

<p>Keep in mind that bulk of the money in the 529 plan came from my pocket. It not a gift from the government with the exception that the government forgave the tax on the earning which is definitely a gift.</p>

<p>What am I missing?</p>

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<p>For some reason I think I’ve read before that money paid from the 529 may be used for the AOC if it’s principal returned, NOT the investment interest. So if $5,000 is paid from a 529 and $4,000 represents “return” of principal and $1,000 is earnings, that $4,000 can be used for the AOC.</p>

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<p>

</p>

<p>Interesting. I’ve never heard this. Do you have a reference?</p>

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<p>In order to take any credit, you actually have to have paid some amount of money. If you take a credit for thermo windows, you have to have paid for the windows, not had them given to you. Credit is to give you back money you have paid for some action the government wants you to take - adoption credit, child care credit. If you don’t spend $10k on your adoption (and money received from your employer or reimbursed by your state doesn’t count), then your credit is reduced or eliminated. The IRS made the rule that there is no double dipping, so you can’t use tax advantaged money to pay and then take the credit.</p>

<p>It may make sense that you could use principal from the 529 account, but the IRS doesn’t always allow things that make sense.</p>

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<p>

</p>

<p>Each 529 distribution is composed of a pro-rata amount of contribution dollars and earnings dollars (assuming there are earnings), based on the existing account balance ratio at the time of the distribution request.</p>

<p>I understand what akmom124 is talking about, but I’ve never heard of it before and would be surprised of it is allowed.</p>

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<p>twoinanddone. My head hurts from all this.</p>

<p>Your logic makes perfect sense. I thought that by declaring the scholarship taxable I was removing that part of the money from the pool of tax advantage money and therefore was actually paying that part of tuition with non tax advantage funds. It seems that by claiming the AOC this way not only do I increase my daughters tax liability but I also decrease my 529 QEE which means that I will face future penalties and taxes due to the 529 fund being overfunded due to scholarships. Still, not a bad problem to have. </p>

<p>In my case:</p>

<p>AOC QEE: 8000</p>

<p>Scholarship: 2500
School grant: 4000
Pell: 5500</p>

<p>Total: 12000</p>

<p>Room and Board: 11000</p>

<p>Therefore:</p>

<p>Option 1) Taxable scholarship is 4000. 529 QEE: 11000-4000=7000 AOC QEE=0</p>

<p>Option 2) Declare additional 2000 as taxable. Taxable scholarship is 6000. 529 QEE: 11000-6000=5000 AOC QEE=2000</p>

<p>As I write this it makes sense but is opposite of what was written by Savingforcollege.com in the article’s comments.</p>

<p>Thank you for preventing me from what could have been a costly mistake.</p>

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<p>I think the problem is that the same expenses do not qualify under the QEE for AOTC as qualify for the QTP for the 529. It is perfectly okay to count room and board in for 529 money, but not for the other, and if you pay a QEE (tuition side) with 520, it’s also okay but then you get no tax credit. In your example above about the student who lives at home, I don’t think the family will qualify for the AOTC because nothing was paid to the school, but the parent MAY (I’m really not sure how it works) be able to take a 529 to cover the room and board (although I think there are requirements that the money has to be paid to a bone fide third party).</p>

<p>Because only $2000 of the AOTC is dollar-for-dollar, I’m going to run the numbers to make sure my daughter isn’t paying more in taxes on that second $2000 (to get the additional $500 credit) than I’ll get back as a credit. This is going to be the only year when this is quite such a decision as she’s only received 1/2 of her scholarships for this freshman year and I only paid the school one semester’s worth of my contribution. Next year, the amount she receives in scholarships will make her tax payment pretty high if I’m moving money all over the place.</p>

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<p>OP
Both options will let you withdraw 529 of $11000 tax free. The room and board expenses do not reduced by any tax free scholarships.</p>

<p>If your daughter declares $8000 (of 12000) as tax free scholarships and $4000 as taxable scholarships,
your AOC AQEE = $8000 - tax free scholarships = $8000 - $8000 = 0; your AOC = 0
your 529 AQEE = $8000 + $11000 - tax free scholarships - AOC = $8000 + $11000 - $8000 - 0 = $11000</p>

<p>If your daughter declares $6000 (of 12000) as tax free scholarships and $6000 as taxable scholarships,
your AOC AQEE = $8000 - tax free scholarships = $8000 - $6000 = $2000; your AOC = $2000
your 529 AQEE = $8000 + $11000 - tax free scholarships - AOC = $8000 + $11000 - $6000 - $2000 = $11000</p>

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<p>4kidsdad: If you read this whole thread up to my last post that is how it looked to me. However , many here stated strongly that the maximum amount that I could use for the 529 distribution is what I physically had to pay. Basically, 19000-scholarship (12000)= 7000.</p>

<p>I have read the pub 970 and will read it again, The rules for AOC seem clear that you can declare part of the scholarship as taxable to be able to qualify for the AOC. I do need to verify that the scholarship/grants can be used for expenses other than tuition.</p>

<p>The rules for the 529 say you need to adjust for tax free scholarships but I saw no mention of adjustments for taxable scholarship. This supports your view.</p>

<p>How these plans need to be coordinated seems poorly explained. Or more likely, I am dense. The basic premise seems to be that you can not double dip or claim QEE that were paid for with tax advantage dollars. Now the question is “are scholarship that are declare taxable tax advantage or not”?</p>

<p>I have 7 days to get to the bottom of this.</p>

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<p>

</p>

<p>To which rules are you referring?</p>

<p>The rules I’m looking at say that “you,” as in the taxpayer, must make the payments for the qualified education expenses (from IRS Pub. 970, pg. 9):</p>

<p>Who Can Claim the Credit</p>

<p>Generally, you can claim the American opportunity credit
if all three of the following requirements are met.</p>

<p>-You pay qualified education expenses of higher education.</p>

<p>-You pay the education expenses for an eligible student.</p>

<p>-The eligible student is either yourself, your spouse, or
a dependent for whom you claim an exemption on
your tax return.</p>

<p>Taking money paid by someone else that would otherwise be non-taxable and declaring it to be taxable does not mean that “you” have now made that payment.</p>

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<p>

Correct. You adjust AQEE for tax-free scholarships NOT taxable scholarships. See <a href=“http://www.irs.gov/publications/p970/ch08.html[quote]”>http://www.irs.gov/publications/p970/ch08.html

</p>

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<p>So declaring pert of the scholarship taxable has no effect on what I can claim as QEE for the 529?</p>

<p>4kidsdad, Is the first part:</p>

<p>“The rules for AOC seem clear that you can declare part of the scholarship as taxable to be able to qualify for the AOC. I do need to verify that the scholarship/grants can be used for expenses other than tuition.”</p>

<p>also correct?</p>

<p>Based on Pub 970:</p>

<p>“Coordination with Pell grants and other scholar-ships. In some cases, you may be able to reduce your tax liability by including scholarships in income. If you are claiming an education credit for a claimed dependent who received a scholarship, you may be able to reduce your tax liability if the student includes the scholarship in in-come. The scholarship must be one that may (by its terms) be applied to expenses (such as room and board) other than qualified education expenses.”</p>

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<p>^There are some scholarships / grants limited to the tuition only, you can’t use them for something else. For example the grant from New York state is called “Tuition Assistance Program.” See <a href=“NYS Higher Education Services Corporation - NYS TAP”>http://www.hesc.ny.gov/pay-for-college/apply-for-financial-aid/nys-tap.html&lt;/a&gt;

</p>

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<p>Thanks.</p>

<p>My daughter’s school has confirm that her scholarships/grants can be applied to any item listed in COA.</p>

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<p>“So declaring pert of the scholarship taxable has no effect on what I can claim as QEE for the 529?”</p>

<p>@noname87, based on what I understood and pieced together from various sources on QEE, I believe by allocating a part of the scholarship as taxable, the adjusted QEE will change (increase). </p>

<p>AMERICAN OPPORTUNITY TAX CREDIT (AOC) ADJUSTED QUALIFIED EDUCATION EXPENSES:
Tuition and student-activity fees are included only if the fees are paid to the institution as a condition of enrollment and attendance.</p>

<p>PLUS</p>

<p>Expenses for books, supplies, and equipment needed for a course of study whether they are purchased from the educational institution or not.</p>

<p>MINUS</p>

<p>Tax-free education assistance, which includes: the tax-free part of scholarships and fellowships, Pell grants, Employer-provided educational assistance, Veterans’ educational assistance, and Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assistance.</p>

<p>Sources:
• <a href=“https://ttlc.intuit.com/questions/1899852-what-are-qualified-education-expenses”>https://ttlc.intuit.com/questions/1899852-what-are-qualified-education-expenses&lt;/a&gt;
• <a href=“Publication 970 (2022), Tax Benefits for Education | Internal Revenue Service”>Publication 970 (2022), Tax Benefits for Education | Internal Revenue Service;

<p>529 ADJUSTED QUALIFIED EDUCATION EXPENSES:
“Withdrawn earnings are always tax-free when total withdrawals for the year don’t exceed the account beneficiary’s adjusted qualified education expenses. Adjusted education expenses equal tuition and related fees, plus room and board (but only if the student carries at least half of a full-time load), plus books and supplies, plus any school-related special needs services; minus costs covered by Pell grants; minus costs covered by tax-free scholarships, fellowships, tuition discounts, and veteran’s education assistance; minus any costs covered by a tax-free employer educational assistance program; minus any costs used to claim the American Opportunity or Lifetime Learning tax credit; and minus any costs used to claim the deduction for tuition and fees.”</p>

<p>Source: <a href=“4 things you don’t know about 529 plans - MarketWatch”>http://www.marketwatch.com/story/4-things-to-know-about-529-plan-withdrawals-2013-09-09&lt;/a&gt;&lt;/p&gt;

<p>This is not to confuse you further, but I thought this webpage provided good information:
<a href=“Your Guide for College Financial Aid - Finaid”>Your Guide for College Financial Aid - Finaid;

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<p>eCoachJen: It appears that you agree with 4kidsdad and savingforcollege.com. Since 4kidsdas to quoting and following Pub 970 rules it seems that I can use $11000 for my 529 distribution without tax consequences.</p>

<p>As a side bar I would like to add my wife’s theory on why this is allowed. The government wants the money to be taken out of the 529 so that it returns to accounts where it can be taxed and hopefully spent. Otherwise people could leave it in the tax shelter earning tax free with no tax streams for the government. You could leave it for another 20+ years and use it for the grandkids. By allowing 529 QEE to not to reduced by taxable scholarships, it is giving an incentive for people to take more money out (since the earnings would be tax-free) and put in back into the economy. To add to this my theory is the government wants to change social behavior (encourage people to save for their kids college education and increase the overall education level) but they do want it to serve as a long term way to avoid taxes.</p>

<p>Isn’t our tax code wonderful?</p>

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<p>

529 could be more wonderful if any 529 leftover be allowed to convert to Roth IRA.</p>

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<p>Personally, I don’t feel that the sum of scholarships/grants(the total of taxable+non-taxable) + expenses used for the AOTC + expenses paid with 529 funds can exceed the total of tuition + mandatory fees + required books and supplies + room and board regardless of how much scholarship money is declared as taxable. Because in that case the expenses being used for the AOTC(which need to be from non-tax advantaged funds) aren’t really being paid by the family. While you may not have to reduce 529 distributions by taxable scholarship amounts, the taxable scholarship portion is still paying expenses, not the family. Who would you write the AOTC expense check to and for what?</p>

<p>But don’t forget to include the cost of required books and supplies in your calculations. They add up to a lot.</p>

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<p>Okay I feel like the horse has ben beaten to death, brought back to life and beaten again.</p>

<p>By declaring the scholarship taxable and paying taxes if necessary, the IRS treats that portion as income no different than any other income. You are paying the AOC and 529 QEE from this income. The source of the income is the provider of the scholarship. The IRS doesn’t seen concerned what the source of the income only that it is income by it’s rules. Any QEE paid with income qualifies for the QEE AOC and 529 distribution. </p>

<p>I need to make this decision today. At this point I will use 11,000. If it turns out to be an error, I have 60 days to roll it into another plan. I would love it if anybody can quote an IRS document that shows this is flawed logic and against the rules. </p>

<p>I fully agree that the reasoning is screwy but that appears to be the tax cox code logic. In my mind, scholarship should be applied to AOC tuitions first and then room an board with no option to declare it taxable to qualify for the AOC. Why should the government give a credit in this case to pay for someone to have the dorm experience?. But I didn’t write the rules. The IRS does.</p>