Coord American Opp Tax Credit with QTP Distribution

[GTS1101]

IRS rules seem very confusing when making a withdrawal from a 529 plan and writing off the American Opportunity Credit. I am looking for some wisdom in this area as I keep going over and over it and can't figure it out completely.

Let's say my client's daughter had 2,271 in tuition and books for 2013. She is in the first year of college a half time student and qualifies for the American Opportunity Credit. My client will be claiming her daughter on her return. In 2013 my client made a withdrawal from a qualified 529 plan to pay for these expenses in the amount of $2,000. $501 of the distribution was earnings and $1,499 was her original basis. My thought is I claim the American Opportunity Credit for the whole $2,271 of expenses and then the daughter would pay tax on $501 of earnings if she was required to file. My thought is since I used all the funds from the QTP for the American Opportunity Credit that the earnings must be taxable. And then there would be no 10% penalty because funds used for the AOC tax credit. Just want to make sure I am understanding this correctly.

Thanks!
GTS1101

[Roland Slugg]

The rules for QTP (529 Plans) are really pretty simple. If the distributed funds are spent for higher education costs, including room and board, for the designated student/beneficiary, nothing is taxable. If distributions exceed qualified expenses, a portion of the difference may be taxable. This is rarely the case.

The availability of the AOC is not dependent on whether or not the funds come out of a 529 Plan. Remember, the 529 Plan was funded by the taxpayer's after-tax money, so it's not taxable when later withdrawn. The benefit is that the earnings are not taxable, either, as long as the proceeds are spend on qualifying college expenses. In this regard it works similar to a Roth IRA: No deduction for what goes in, but no tax on anything that later comes out ... as long as the simple qualifications are met.

[TaxGuyBill]

Yes, I agree. Parents use $2271 for American Opportunity Credit and daughter pays tax on $501, with no penalty.

http://www.irs.gov/publications/p970/ch08.html#en_US_2013_publink1000178546

As Roland pointed out, was there any room and board? If so, that qualifies for a 529 plan, and the daughter probably would not need to pay the tax on $501.

http://www.irs.gov/publications/p970/ch08.html#en_US_2013_publink1000178526