Education expenses and 529 withdrawals - assistance requested

[FEDUKE404]

Dependent Jane has been attending College X on a full scholarship, and graduated in May of 2015. Prior to 2015, there have been no education credits available to parents and taxable income from the scholarship has been duly reported each year on Jane's income tax returns. Jane's younger brother John is now a college student. Their parents are ineligible for the LLC due to their income, but will likely qualify for some AOC/T&F considerations on their 2015 joint tax return.

During 2015, Jane continued her education at College X and she is now in graduate school at College X. (She also took a summer course at College X to acquire a missing credit required for graduation.)

A withdrawal was made from a state 529 plan to pay for summer school and graduate school. Due to a miscalculation, the parents withdrew "too much" from the 529 plan and repaid the overage within the allowable time frame (60 days??) during early 2016. The Form 1099-Q issued in Jane's name shows only the original (incorrect) distribution.


Question #1: Can Jane's 2015 full-year allowable expenses be used for the AOC? As of 01/01/2015 she had NOT completed four years of undergrad school. However, the infamous 2015 Form 1098-T from College X does have Box 9 (graduate student) checked. It should be noted that the spring semester 2015 college expenses (when scholarship was in play) were reported on the 2014 Form 1098-T from College X.

Question #2: How do you handle the 2016 "repayment" of the 529 expenses as related to Form 1099-Q? (Is there such a thing as a "corrected" Form 1099-Q ??) In theory, we can recalculate the amount of distributions shown in Box 1 of the Form 1099-Q and then calculate any allowable education credits. (Even with "the fix" it is likely some of the 529 withdrawal will be taxable to Jane and same will be reported on line 21 of Form 1040.) But then, would there be a potential IRS document mismatch problem looming? Would the amounts in Box 2 and Box 3 of the Form 1099-Q not also be impacted?

All input will be welcomed!!

FE

[DonB]

Question #1: Can Jane's 2015 full-year allowable expenses be used for the AOC? As of 01/01/2015 she had NOT completed four years of undergrad school.

Question #2: How do you handle the 2016 "repayment" of the 529 expenses as related to Form 1099-Q?



FE

TB 12-6 says you do not report anything from the 1099-Q if the distribution is less than the the adjusted qualified expenses. I would ignore the repayment issue and keep the documentation in case of an unlikely inquiry.

From your facts, I would take the 2015 adjusted qualified expenses paid in 2015 for the AOC. The 1098-T stuff can be explained.

[FEDUKE404]

Taxable 529 distirbutions

TB 12-6 says you do not report anything from the 1099-Q if the distribution is less than the the adjusted qualified expenses. I would ignore the repayment issue and keep the documentation in case of an unlikely inquiry.

From your facts, I would take the 2015 adjusted qualified expenses paid in 2015 for the AOC. The 1098-T stuff can be explained.

Perhaps you misread: For both Jane and John, the 529 plan distributions they received will be more than their adjusted qualified expenses. They both will likely have some line 21 Form 1040 taxable income to report on their personal returns. (Both Jane and John are being claimed as dependents by their parents.)

Side issue of relevance: Within the past two weeks I had a client who received a deficiency notice from the IRS for "unreported income" for a 2014 529 plan distribution, reported on a Form 1099-Q, that was completely consumed by allowable expenses for his (non-dependent, lives with mom) daughter's education. Apparently the IRS does monitor the Forms 1099-Q ?

I would agree with you that there is much that can happen between the number shown in Box 1 of the Form 1099-Q and what (if anything) gets reported as taxable income on line 21 of Form 1040. Perhaps the tax software ("student") worksheets send something relevant to the IRS, but I doubt it.

FE

[TXEA]

Here are a couple of things that may help:

For Jane.......taxable 529 Possibility..... If you are just looking at the 1098-T for the costs, remember that the 529 Plan can also be used for housing costs up to the Department of Education published housing rates for the school ( I have seen many schools that publish the amount). The housing amount can be used even if the student is living off-campus. This may help with the overage if you have not factored in this cost.

As for claiming the entire amount of the 2015 costs for Jane....Here is the IRS position which applies to Jane:

Q13. If a student was an undergraduate during the first part of the taxable year and became a graduate student that same year, will the student qualify for the American opportunity tax credit?

A. If a student has not completed the first four years of post-secondary education as of the beginning of the taxable year, and has not claimed the Hope scholarship credit and/or the American opportunity tax credit for more than four taxable years, the student can claim the American opportunity tax credit for qualified expenses paid during the entire taxable year.

Source: IRS.gov AOTC questions and answers

As for the repayment of the excess from the 529 Plan.....

I have always attached my calculation of the 529 plan tax free amounts with a schedule included with the electronic file. I show the distributions by date and the education costs incurred by date. At the end of your schedule, if you have an excess, and the excess was paid back in, then show the excess, then show the repayment, the date of the repayment, and then zero out any excess. I have used this schedule for many clients with the return, and I have never had an IRS letter questioning taxable amounts. While the IRS claims nothing is required to be reported if the 529 Plan distribution is not taxable, I have seen them ask for proof, so I provide this same schedule that I have to prepare to determine if any amount is taxable.

[FEDUKE404]

Dealing with 529 taxable income et al

Here are a couple of things that may help:

For Jane.......taxable 529 Possibility..... If you are just looking at the 1098-T for the costs, remember that the 529 Plan can also be used for housing costs up to the Department of Education published housing rates for the school ( I have seen many schools that publish the amount). The housing amount can be used even if the student is living off-campus. This may help with the overage if you have not factored in this cost.

As for claiming the entire amount of the 2015 costs for Jane....Here is the IRS position which applies to Jane:

Q13. If a student was an undergraduate during the first part of the taxable year and became a graduate student that same year, will the student qualify for the American opportunity tax credit?

A. If a student has not completed the first four years of post-secondary education as of the beginning of the taxable year, and has not claimed the Hope scholarship credit and/or the American opportunity tax credit for more than four taxable years, the student can claim the American opportunity tax credit for qualified expenses paid during the entire taxable year.

Source: IRS.gov AOTC questions and answers

As for the repayment of the excess from the 529 Plan.....

I have always attached my calculation of the 529 plan tax free amounts with a schedule included with the electronic file. I show the distributions by date and the education costs incurred by date. At the end of your schedule, if you have an excess, and the excess was paid back in, then show the excess, then show the repayment, the date of the repayment, and then zero out any excess. I have used this schedule for many clients with the return, and I have never had an IRS letter questioning taxable amounts. While the IRS claims nothing is required to be reported if the 529 Plan distribution is not taxable, I have seen them ask for proof, so I provide this same schedule that I have to prepare to determine if any amount is taxable.

Thanks, TXEA. My conclusions are pretty much in line with what you cited.

Rest assured, we have milked everything we can to offset the 529 distribution to include the "allowable" housing cost since Jane is now living in an apartment. It even gets creative when the issue of "required" costs for books and fees comes into play. As for the Form 1098-T info. . .well, that carries little weight. Fortunately, Jane's mom is being quite diligent about tracking expenses along the way.

I will consider your "explanation" of the 529 distribution repays. There is an area for "explanations" that accompanies any efiled return, and that might be a good place to tell the tale. As an alternative, I was considering a second line 21 Form entry to accompany the taxable amounts generated from the received Form 1099-Q. That entry could be something like "repayment of 529 distribution" or similar. I'm still a bit concerned about the accuracy of Boxes 2 & 3 on the Form 1099-Q when a different "distribution" amount effectively is used for Box 1 "gross distribution." But that is something I have no control over. Perhaps the 529 plan folks will offer a resolution there taking into consideration the repayments.

I don't recall ever having a client with a combination of education-related tax events such as Jane's family has for 2015. It appears that parents may get AOC for both Jane and John. . .a pleasant and unexpected surprise. While both children will likely have line 21 taxable income from the 529 distribution (the time for "correction" had passed for John), even without having their personal exemptions to use their overall tax will be quite low. I will have to do some further digging, as the rules for whether Form 8615 (kiddie tax) might apply seem to change each year.

Again, thank you for your input and the time you spent replying.

FE