My daughter is a freshman at an in-state public university and I’m struggling with whether or not we can/should take a distribution from her 529 to reimburse us for out of pocket expenses paid for the Fall 2017 semester. I’ve read IRS Pub 970 and researched online all day and am still confused. Any help would be appreciated! Here are the numbers:
Qualified Educational Expenses (tuition, required fees and books) - $7,085
On campus room and board - $5,888
Other Billed Expenses - $151
Total Scholarships - $10,025
Expenses Paid Out of Pocket - $3099
Based on our situation, I believe that it will be advantageous to use $4000 of the $7085 QHE to generate the full American Opportunity Tax Credit of $2500. Therefore, the QHE remaining would be $3085. We can use $3085 of her $10,025 scholarship money tax free to cover this remaining QHE. That leaves $6940 of her scholarship money which would need to be reported as taxable income.
My question is around room and board. The scholarship money left over in the above calculation ($6940) is sufficient to cover the room and board ($5888). However, on-campus room and board expenses are considered QEE (and therefore reimbursible without penalty) as far as the 529 money is concerned. We had actual out of pocket expenses of $3099 that I would like to get reimbursed from the 529 account tax and penalty free if possible. Since this $3099 is less than the $5888 cost of the room and board, could we take the 529 distribution for $3099 for room and board even though the calculation above shows we had taxable scholarship money sufficient to cover the whole cost of the room and board? The scholarship money in question is not restricted as far as I’ve been able to find.
So if you pay the school $4000 in cash and $3099 from the 529 the school will refund you from the scholarship amount you have to use for travel, supplies, etc? To keep everything straight for the IRS you really want to pay directly to the school if possible. Yes if the school allows any use of the scholarship money this would work but that is rare. You (and the IRS) will get a 1098 showing what you paid (ours doesn’t differentiate between cash and 529 payments) and the QEE. In terms of the income of $6940 as long as she pays taxes on it I don’t think the IRS cares what it is used for but if the school applies it directly to her account I’m not sure how they would handle you basically wanting to overpay and cash out. Neither of my kids schools work that way but every school is different.
I don’t think OP is talking about making any kind of additional payment/overpayment to the school. It sounds like the question is about making the 529 distribution payable to the 529 account owner/parent to cover QEE that was already paid for out of the parent’s pocket. There is nothing unusual about this. The dilemma is what to do so that $4,000 of non-tax-advantaged money can be used to claim the full American Opportunity Tax Credit.
Disregarding the $151 for “Other Billed Expenses” (without knowing what specifically the expenses were, I have no idea how they should be treated), the student will at least need to declare $2,940 of the scholarship as taxable. If you want to take the full AOTC, the student can declare an additional $4,000 of the scholarship as taxable. The distribution of payments would look like this (again, disregarding the $151 for “Other Billed Expenses”):
Tuition, required fees, books
$7,085 – $4,000 taxable scholarship to be used for claiming AOTC
– $3,085 non-taxable scholarship
Room and board
$5,888 – $2,940 taxable scholarship
– $2,948 paid out of pocket, to be reimbursed from 529 distribution
Thanks BelknapPoint. That helps. Incidentally, the $151 in “Other Billed Expenses” was comprised of a $50 Living/Learning Community fee and a $101 Student Health Center fee. LLC’s are obviously optional, so that would just be an out of pocket expense. IRS Pub 970 says that “student health fees” are not qualified expenses with respect to the AOC, but maybe they are for 529s. Anyway, the amount is small so it’s fine to disregard.
Here’s my follow-up question. If the $2940 taxable scholarship amount in the second calculation above is not restricted in terms of its use (e.g. the ACT-score based merit scholarship the school provides with no restrictions on usage that I could find), then since we are paying taxes on it can it be treated just as regular income and not “used” to pay part of the room and board expenses? I’d like to take the full $5888 out of the 529 account if possible. I’m trying to get the money back out of the 529 account (in its full tax advantaged glory) by all legitimate means so we can avoid having money left over for which the tax advantages disappear.
this is confusing to me. How does a kid declare part of a school-sponsored merit scholarship as taxable, when the school sends you a 1098 listing the whole scholarship? Is there a spot on the taxes to do this? OP - will your school give you a 1098 with that amount showing?
we are in the same boat and have not found a work-around; to flip-flop money we pay for tutition and have scholarship money for R&B, thus giving us money back for AOTC.
The first $2,000 of QEE result in a $2,000 AOTC. So maybe you could claim less AOTC and then pay more of room and board with 529.
Did the student get a new computer? I believe that is a qualifying expense for 529 as well.
When I fill out the interview in the tax software, I indicate that the amount of the scholarship I want to make taxable pays for room and board.
That automatically makes it taxable then and is entered in the wages line with SCH next to it.
Thanks for the comments. What a confusing system! This is my daughter’s first semester, so the upcoming tax season will be our first where we have to deal with all this. I don’t know what to expect on the 1098 from the school. I think to be safe this first time around I’ll just allocate the $2940 of taxable scholarship money in question toward room and board and only claim the leftover R&B expenses ($2948) from the 529. It seems like if the scholarship isn’t restricted and we’re paying taxes on it, we should be able to treat it as ordinary income and use 529 expenses to pay all of R&B, but I don’t want to be sweating it if we were to get audited so I guess we’ll play it safe this time.