Coordinating AOTC With Too-Large Sec. 529 Withdrawal

[josephanthony]

Grandparent withdrew $10,000 from 529 plan to cover grandchild's tuition; $3,000 was earnings. Plan is in the grandparent's name & she is the recipient on the Form 1098. Grandchild had only $10K tuition bill and only $2,000 of room & board expenses.

Looking at the no-double-dip rules, it appears that the best path for the parent would be if the $2,000 of room-and-board was applied against the 529 withdrawals, and $4,000 of tuition was applied for AOTC purposes. We would then have $4,000/$10,000 x $3,000 = $1,200 taxable distribution. But taxpayer would get the full $2,500 AOTC.

Does this make sense? Haven't had someone before who was in such a good position that their 529 withdrawal would cost them their AOTC...

Joseph Anthony

[josephanthony]

Correction on the math--With $2,000 applied to room-and-board, there'd be only $2,000 withdrawals disallowed for AOTC purposes. So $2,000/$10,000 x $3,000 = $600.

[TaxGuyBill]

Yes, I agree that $600 is taxable.

I approach the math from the back side. You want to keep $4000 of the American Opportunity Credit no matter what. That leaves $6000 of tuition and $2000 of Room&Board for qualified 529 plan withdrawals.

So that leaves $2,000 of withdrawals for non-qualified purposes. 30% of the 529 is from earnings, so 30% of the non-qualified 529 plan withdrawals is taxable, which means $600 is taxable.

[josephanthony]

Many paths to the same enlightenment--I love it! Thanks--I am sure the grandparent will have no problem at all with paying tax on $600.

Joseph Anthony