Coverdell ESA

[RitaB]

Kid's qualifying education expenses (adjusted for scholarships, grants) are 1,000. (There is no room and board; tuition and books only.)

1099-Q issued to kid: Gross Distribution = 1,000. Earnings = 200. Basis = 800.

Do I have this right? Can I do either of these two things (assuming all the stars are aligned for parents to qualify for education credits)?

1) Report the 200 on kid's return as income. Not subject to 10% penalty because he DID use the entire distribution for education expenses. Take the 1,000 expenses on parent's return.

2) Report nothing on kid's return, and take 800 expenses on parents' return.

[BP.]

Rita, after you have the qualifying education expenses of $1,000 figured, then deduct from that the amount used for any tax benefit (AOC, LLC or T&F Deduction) taken on the parents' return, to figure the resulting Adjusted qualifying education expenses, if you didn't do that already. It looks like the $1,000 would be available for that purpose.

Then after that, see if any of the earnings portion is taxable to the beneficiary, not subject to 10% penalty.

See TTB 12-4- the example and the formula.

[BP.]

And try checking out pub 970 pp. 54-55.

So yeah option #1!

[RitaB]

Option #2

And try checking out pub 970 pp. 54-55.

So yeah option #1!

Thanks, Barb. So, Option #2 not possible here, is it? The entire 1,000 gross distribution is off the table for credit purposes if the earnings on the ESA is tax free, correct? 1,000 is the grand total of kid's expenses. If he does not report the earnings as taxable, the parents cannot use any of the 1,000 for credits, right?

[BP.]

Won't it be more beneficial for the parents to take a credit based on the $1,000 and then have some or all of the earnings on the 1099-Q be taxable, or at least reportabe, if reporting is even needed?

The beneficiary still might be under the filing threshold if no other earnings, so the 1099-Q earnings are effectively tax free.

[RitaB]

Yes, absolutely

Won't it be more beneficial for the parents to take a credit based on the $1,000 and then have some or all of the earnings on the 1099-Q be taxable, or at least reportabe, if reporting is even needed?

The beneficiary still might be under the filing threshold if no other earnings, so the 1099-Q earnings are effectively tax free.

Oh, yes, absolutely, I just wanted to get my mind around whether or not Option #2 was possible.

Option #1 saves the family $980. Parents get $1,000 AOC and kid pays $20 by reporting the interest. Obviously that's what I did. But I'd like to know if I have it correct in my mind now - that Option #2 is not even possible. If they save the tax on the earnings, they would in essence waste the AOC completely.

I think that's why ESAs are pushed on the "wealthy" - here's your only chance at saving any money on college expenses cause your income is too high to get credits.