So, I just got off the phone with my tax preparer and am a little shocked. I thought I had done everything the right way. We had $11,800 in qualified expenses. I withdrew $10,800 from a Coverdell account to cover these expenses. Son received $10,000 in scholarship. I also withdrew $3700 as a non-qualified expense from his 529 plan as "scholarship", of which $660 is taxable interest.
Tax preparer said that there is a formula that adds up ALL withdrawals and ratios them proportionally. So now I am possibly going to have to pay tax on $2100 instead of $660. (If I hadn't taken the 529 "scholarship" there wouldn't be a problem)
My question is: How do I effectively withdraw the 529 money as a scholarship? (especially if I cannot take Coverdell and 529 distributions in the same year due to this worksheet requiring all distributions to be lumped together.)
One plan would be to use up the Coverdell first, but then the entire 529 would be left untouched. (I know … good problem to have.) Son earned this money through his studies to be awarded the scholarships. The money is his. I won't be transferring it to his sister. I want him to be able to receive all of it and I don't want to be hit with extra taxes because I saved. I am unable to take advantage of any tax break (AOT or other ed tax benefits).
Any help as to how to withdraw scholarship money would be appreciated.