College payments from 529 plan for a non-dependent

[Raymond Martin]

This may have been addressed before either here or on another message board, but I have not found anything on point. Background: In 2019 parents used 529 plan funds to pay their daughter's tuition. The daughter graduated during the year and wants to file separately. My questions are as follows: 1) If the daughter is not a dependant, is the interest earned on the 529 plan tax-free for the parents? The 1099-Q was issued in the parent's name and SS number. 2) If the daughter is not a dependant and the interest would be taxable to the parents, is there a way to have the interest be tax-free on her return, i.e. she use the information shown on the 1099-Q? Thank you in advance for your insights and expertise.

[Lion]

Are you sure the daughter does not qualify to be a dependent?

See TTB tab 12, especially 12-3 Coordinating Education Benefits.

[terryats]

I used ProSeries software, and when you are filling out the 1099Q worksheet it ask who is the funds for, and you answer someone else. then you fill out a student worksheet saying that the student did not attend college, but you continue to fill worksheet with tuition info. I'm sure the software you use has something similar. bottom line the distribution is not taxable if used for school tuition

[Dude]

Sounds like the parents received the money and then paid the school thus they got the 1099 Q..was all the money used for qualified education expenses? If so no interest charge. Should have had the money sent directly to the school. https://www.irs.gov/pub/irs-pdf/p970.pdf

[Burke]

The facts in the original post state the daughter wants to file separately. Why would she want to deprive them of the benefit of claiming her? If she graduated in 2019, and is under age 24, she qualifies as a student where her income is not part of the equation for claiming her. They lose the $500 dependent credit and the tuition credits/deduction, whichever one they may qualify for. I don't think she gets anything for education credits/deductions if she is eligible to be claimed as a dependent by someone else, whether they do or not. Correct?

[dtlee]

I apologize in advance if this post is irrelevant since I am unclear what I am reading about.

There is no requirement I am aware of that the designated beneficiary of a Qualified Tuition Plan be a dependent. However, if the daughter did not attend college, as one response seems to have interpreted the scenario, then the earnings would be taxable, but it seemed clear that this was a student enrolled in a college for which the funds were spent.

Whether or not the parents claim the daughter is not a factor in determining whether the daughter can claim herself (unless "separately" means something else, like "Married Filing Separately"). A person who is able to be claimed as a dependent by another is not able to claim certain benefits regardless of whether or not the person is actually claimed.

Thus, I agree with Feduke and Dude.

Regarding the post by Burke. The issue is not really that simple. It depends on the tax benefit. For the Tuition & Fees Deduction, you cannot claim it when you are able to be claimed a dependent regardless of whether or not you are actually claimed. For the Lifetime Learning Credit, you can claim the credit as long as no one else does claim you. For the American Opportunity Credit, the nonrefundable portion works similarly to the rules for the Lifetime Learning Credit, but the refundable portion is not allowed to anyone who is potentially subject to the Kiddie Tax (based on age, living parents, earned income, etc.), regardless of whether or not they actually have income that would be subject to the Kiddie Tax. Thus, if no one claims the student, they get the nonrefundable portion and, assuming the child is over 18, if she is over 24 or if she is under 24 and any of these, she can get the refundable portion:

• Not a full time student during the year
• Has earned income that exceeded half of her support
• Has no living parents
• Is filing jointly with a spouse (part of why I am confused about the "separately" part)

[Raymond Martin]

To clarify, some questions from the original post, the daughter attended school and the 529 plan distribution (for which the 1099-Q was issued to the parents) was paid to the school for the tuition. The daughter, who is unmarried, then went to work and earned over $20,000 after she graduated and she thinks it will be better for her to file separately. She still could qualify as a dependent of the parents based on the information that I have obtained. The AOC is available for 2019 for her and I am doing a comparison of both scenarios (parents claiming daughter vs them not claiming her) to try to get the best tax situation for the family.

From the answers given, it appears that the interest on the 1099-Q distribution is not taxable whether or not the daughter is a dependant as long as it was spent on the tuition. Correct? But now I am a bit confused as to whether the daughter would get the full AOC credit if she files separately. I understand that the AOC credit goes to the parents if they claim her.

Finally, maybe I missed it, but was the Tuition and Fees deduction re-instated?

Thanks for all your help.

[dtlee]

You have determined that the daughter could qualify as a dependent. That eliminates the Tuition and Fees Deduction on her return. It would be allowable on the parents' return if they claimed her since it has been reinstated (back through 2018).

Based on what you stated (and I am trying to read between the lines) the daughter is eligible for the full nonrefundable portion of the American Opportunity Credit on her return, but since she was a full-time student for at least 5 months of the year and under age 24 (with living parents) then if she was earning half of her support needs or less she cannot get any of the refundable portion of the American Opportunity Credit.

She cannot combine her income with her parents on their return and must file as a dependent on her own return (this is true regardless of whether or not her parents claim her as a dependent on their return).

[Raymond Martin]

Thank you to all of you for all your input. After doing the analysis, the best tax situation for the family is for the parents to take the daughter as a dependent on their return. I have talked to them about reimbursing their daughter for the tax difference that she will experience.

[Burke]

Thank you to all of you for all your input. After doing the analysis, the best tax situation for the family is for the parents to take the daughter as a dependent on their return. I have talked to them about reimbursing their daughter for the tax difference that she will experience.

And that is generally the case for the dependent's graduation year. Her parents are being generous, but we often suggest that if they are interested. Often works with other situations too, when filing status, etc is in the equation between 2 different taxpayers.