Can I still qualify for AOTC?

aelaino1 2018-02-14 22:04:07 UTC #1

I incurred $10,000 in T-1098 qualified education expenses for my child. I withdrew $10,000 from my 529 savings account. The withdrawal consisted of $2,000 in earnings and $8,000 of my contributions (basis). Can I still qualify for the AOTC since $8,000 of the qualified education expenses were paid for from my basis?

dcandmc 2018-02-15 04:02:40 UTC #2

No; if the AOTC qualified education expenses were all paid with tax-advantaged funds (and this includes every 529 dollar), you can't claim the AOTC unless you choose to pay taxes on funds used for payment that would otherwise have been tax-free.

aelaino1 2018-02-15 13:48:33 UTC #3

Interesting. The Code section in Publication 970 indicates the expenses but does not clarify whether the tx free earnings or the basis must be coordinated to claim the AOTC. In another publication through Forbes, the interpretation is "It is very important to remember that you cannot claim any of the college tax credits, including the AOTC, based on expenses that were used to calculate the tax-free portion of a distribution from a 529 college savings or prepaid plan, or a Coverdell Education Savings Account (ESA). The AOTC may be claimed in the same year that a tax-free distribution is made as long as the same expenses are not used to calculate the tax-free distribution AND the American Opportunity Tax Credit." The basis of the 529 is not tax free. It is after-tax funds in a tax-favored account. I interpret the tax-free portion to be the tax qualified earnings. This is a very murky code. Hey CPAs out there, where do you stand on this interpretation? Joe Hurley, what are your thoughts?

dcandmc 2018-02-15 15:57:34 UTC #4

You can't separate the after-tax basis part of a 529 distribution from the earnings portion of the same distribution. A 529 distribution will always conform to whatever the then-existing basis to earnings ratio happens to be in the overall account.

dopps 2018-03-21 15:28:06 UTC #5

Right--you can not "double dip" by getting TWO tax advantages for the same withdrawal. So, as a future strategy, always short your qualified withdrawals from your 529 by $4,000 in order to get the maximum AOTC of $2500 (assuming you qualify financially for said AOTC). I have employed this successfully for all 8 of my children's college years.

velaga 2018-06-17 23:26:06 UTC #6

That will definitely work but my understanding is that you don't have to necessarily withdraw $4,000 less than the total qualified expenses. You can withdraw an amount equal to the total qualified expenses so long as you are willing to treat $4,000 of them as non qualified withdrawal (so that $4,000 can be used for AOTC eligibility) and pay taxes on the earnings portion of that $4,000 as dcandmc also mentioned earlier. So in this case, aelaino1 will have to pay taxes on $1,000 (prorated earnings portion of $4,000) of ordinary income and claim the full benefit of AOTC.

If the student is the one claiming AOTC then, a portion of it may go unused unless the student has other income (earned income, investment income etc.) so AOTC can offset some or all of the taxes on that income.

dopps 2018-06-18 15:43:43 UTC #7

Actually, the ratio for aelaino1 is 1/5 (or 20% is earnings), so $800 will be taxable and penalized for a $4000 non-qualified withdrawal. I suppose one could go that route, but why pay taxes and penalties at all, unless the family doesn't have $4000 outside of the 529?

dcandmc 2018-06-18 17:06:22 UTC #8

The 10% additional tax ("penalty") won't apply if the earnings portion of a 529 distribution is included in income only because the qualified education expenses were taken into account in determining an education tax credit.

velaga 2018-06-18 17:59:02 UTC #9

You are correct it is $800 and not $1,000. I made a mistake in calculating it. There are no penalties in this case.

Regarding your question on why wirhdraw thise $4,000 and pay taxes, there may be several scenarios where it makes sense. Examples include a super funded 529 account, parent being in a low tax bracket temporarily, lucrative state tax deductions on new contributions from parent or a relative in a high tax state that more than offset the taxes while also increasing cost basis, students not being a dependent and claiming AOTC in which case AOTC credit can wipe out the taxes resulting from this $800. In fact in the last case, it will wipe out a lot of taxes on any other income also including gains from selling appreciated stock donated by parents or others.