I have a 529 plan (Florida Prepaid) for my daughter who I'm claiming as a dependent. The Florida Prepaid 529 Plan paid $1577 of the $2284 expenses for her 2009 university year.

In order to maximize the deduction from the American Opportunity credit, it seems that if I could claim all of the $2284 as expenses and then claim the Earnings portion of the 529 distribution ($928) as taxible income (plus 10% penalty), this would result in a lower tax for me. The taxes and penalty for the 529 earnings ($928) is much less than if I left ALL of her University expenses ($2284) in for the American Opportunity credit instead of reducing the expenses by the 529 plan distributiuon amount ($1577).

From irs Pub. 970 it say.. " An American opportunity, Hope, or lifetime learning credit (education credit) can be claimed in the same year the beneficiary takes a tax-free distribution from a QTP, as long as the same expenses are not used for both benefits."

So if we pay the taxes and penality on the Earnings from the 529 plan, I should be able to deduct the full expenses for the purposes of determining the American Opportunity Credit. Or because the fact that the Florida Prepaid made payments directly to the University for my daughters tuition am I not able to do this switch of the funding?

Also, since the 1099-Q is in my Daughters name, I guess I would have to report the $928 as income on HER Income Tax. However, I would like to take the American Opportunities tax credit on MY Income Tax to maximize the credit (I'm the one that paid for the Florida Prepaid 529 and all of her university expenses).

Thanks for the advice on this, I'm sure there are many in this same decision process now....

From what I can find on-line, it looks like if I used the 529 Plan I need to reduce the university expenses by the amount distributed from the 529 plan. The 1099-Q form shows how much is my BASIS and how much is EARNINGS. Can I just reduce the unitversity expenses by the amount of the 529 EARNINGS - since those are tax free - and NOT include the BASIS amount (since that's what I paid into the 529?)...

I read someplace that the I needed to reduce the 1098-T expenses by the amount on 1099-Q box 1 - which is the entire 529 distribution (EARNINGS and BASIS)... I'm just thinking that the EARNINGS is the only thing I need to deduct... Am I right?

Thanks..

From how I understand your situation you should claim the credit on all qualifying expenses. Some, all, or none of the $928 in 1099-Q earnings will be taxable on your daughter's return, depending on whether she incurred room and board or other 529-qualified expenses that could not be counted toward the credit. The 10% penalty tax on any taxable earnings is waived because the 529 distribution would have been tax-free if you had not claimed the credit (that's one of the exceptions to the penalty).

Joe

Step 1: Count up all your 529 expenses.
Step 2: Count up all your AOTC/Hope/Lifetime expenses (up to the limit)
Step 3: Subtract Step 2 result from Step 1 result.
Step 4: Compare Step 3 result to TOTAL distributions on 1099-Q. If total distributions are more, then some portion of the earnings on 1099-Q will be taxable, but may be eligible for 10% penalty waiver.

Joe

Thanks Joe... I understand what I need to do now...

Step 1 - 529 Expenses $2,284 (my daughter lived at homre - so no room/board expenses)

Step 2 - AOTC expenses - $2,284

Step 3 - Substract Step 1 from Step 2 = $0

Step 4 - Total 1099-Q = $1577

Since 1099-Q $1577 < $2,284 all of the 529 expenses WOULD have been spent on educational expenses... so no tax...

I'll just claim the Earnings from the 1099-Q on my Daughters 1040 and I will claim the AOTC credit on my 1040 ... a Win-Win... Thanks for the feedback...

To Gatorgogo - thanks for answering my question in the TurboTax forum. I figure I'll move to this forum. My situation is very similar:

If I understand this correctly:
Step 1 - My 529 expenses (from 1098-T, box 2) = $4614
Step 2 - AOTC expenses = $4614 (capped at $4000 on Form 8863) I reality, this is ok because tuition is $4614, books are $492 but he got a $1000 scholarship so the true expenses = $4106
Step 3 - Step 2 minus step 1 = $0
Step 4 - Total 1099-Q = $4539 < $4614 so all of the 529 disbursement went toward educational expenses, hence no tax.

Therefore, I should claim the $4000 AOTC on my taxes and my son can file his taxes at a lower tax rate using the 1099-Q.

Now, on his taxes, he will claim the $2200 in earnings from Box 2 of 1099-Q. I believe he also has to claim his $1000 scholarship. All of this is taxed (10% penalty is waived) but at his tax rate.

Pub 970 says if you use a 529 to pay for education, the purchase of a computer and internet access are considered qualified expenses. Since he's claiming the 1099-Q, I believe he's entitled to those expenses... I hope.

OK - so how'd I do? Am I even close?? Thanks so much. I hope this helps a lot more than just me!

Perhaps I am confused, set me straight if so, but I don't understand all the concern over earnings vs. basis on the 529 distribution. I see a mention of tuition and books as qualified expenses, but are we overlooking room & board? Room & board are qualified expenses for 529 distribution, don't confuse it with eligible expenses for tax credit calculation, where it is normally not eligible. Scholarship also not taxable so long as applied to tuition, perhaps books & supplies.

Hoosier, you are correct. My step 1 above would include all qualified higher education expenses including a limited amount of room and board. Gatorgogo says beneficiary had no room and board (although there probably is some even for the student living at home). irunalot incorrectly uses 1098-T for step 1. 1098-T is irrelevant for purposes of step 1.

Joe

Every now and again, a ray of hope. Maybe I'm getting it. I'll try this again:

The first step is just listing out all qualified higher education expenses (forget about the 1098-T).

The second step is listing out AOTC expenses (capped at $4000).

In the third and fourth step, you're establishing how much of QTP earnings are taxable (in my case, on the student's taxes). To do this, you have to subtract the AOTC amount from the 529 expenses, and compare the result (the remaining expenses) against the total 529 distribution. If the 529 distribution is higher than the remaining expenses, there could be a tax consequence.

If this is correct, it really looks like a great tax benefit for a family with student(s) in higher education. Thanks a lot for the help!

irunalot,

Now you have it. Best of luck.

Joe