Dad pulled money from 529 to pay sons tuition but he can't claim him as a dependent

[TLFORD]

I have a client that pulled money from a 529 plan and received a 1099Q and has the statement from the college where he paid his sons tuition.  The 1099Q shows the son as the beneficiary but the withdrawl was from the administrator (dad).  The son is not able to be claimed on the dads taxes due to the divorce decree.  Is there a way to put this in using proseries and the dad not be penalized?

[rbynaker]

The recipient of the funds has to deal with reporting (if necessary).  Sounds like that's the son in your case.  Generally this goes one of two ways, 1) Dad gets a check from the plan and then pays expenses.  Dad gets the 1099-Q.  2) The plan sends the check directly to the school and the beneficiary gets the 1099-Q.

If the 1099-Q is in the son's name/SSN then have Dad give it to him to deal with.  This can be more of an art than a science since the ordering rules are taxpayer friendly and *someone* may get a nice AOTC refund (ex-wife?) if little Johnny picks up some taxable income.  Very situational though.

Rick

[TLFORD]

It was scenario 1.  Dad got the 1099Q but he can't claim the kid.  It's causing an $1,100 penalty for dad and trying to see if there is anything I can do.

[sjrcpa]

If Dad used the money for qualified education expenses of the son beneficiary - no tax, no penalty.

It doesn't matter if Dad can claim son as a dependent.

Heck, I've grandparents getting these for 4, 6, 8 grandchildren.

[rbynaker]

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@sjrcpa wrote:

If Dad used the money for qualified education expenses of the son beneficiary - no tax,

RB: well, maybe.

no penalty.

RB: agree.

I wish it were that simple but I had one last year that was a mess.  Grandma never told me she opened a 529 plan for granddaughter umpteen years ago and in 2020 decided to cash out the entire plan and give all of the money to granddaughter in her first year of college.  Mix that up with charges for Fall 2020 & Spring 2021 tuition / room & board, much of which was credited back because the school decided to do distance learning and the granddaughter lived at home with a lighter course load than she originally applied for.

So I started digging and it ended up that the parents were "in the zone" for AOTC.  So we were able to maximize AOTC on the parents' return but that meant that we couldn't "double dip" on those expenses to make all of the 529 plan non-taxable.  Using the expenses to claim a credit (and/or having expenses paid by scholarship) is enough to get out of penalties.

So maybe ex-wife or daughter will use the expenses to claim AOTC and dad can't double dip with them.

IMO this whole concept is completely broken.  I was lucky enough to have a cooperative granddaughter/daughter to get the information needed to maximize the tax savings for the family (at the direction of my client) but there are plenty of situations where one taxpayer can't get the information needed to file a complete and accurate tax return.

In this particular case, I'd at least ask if there's any AOTC involved on somebody else's return but since it won't be on Dad's return, I'm not subject to due diligence for it.

My client was not thrilled about the bill (I charge by the hour) but I put a note on it explaining how much we were able to save "the family" in taxes by doing all of the research and going line by line through the tuition bills to grab everything we could possible find that qualified.  I attached a detailed calculation and identified the granddaughter so maybe the IRS can "find" education expenses on the 1098-T under her name/SSN.  No idea if it's enough to avoid a nastigram but we're 10 months into a 3 year SOL...

Are we having fun yet?

Rick

[Frustrated-in-IL]

Just because dad used the money for qualified expenses does NOT mean no tax.  If someone claimed college credits for this student, dad probably has some tax.

[Frustrated-in-IL]

There is another potential issue here.  The original post says dad isn't claiming son because of the divorce decree.  If the son is emancipated in the state where they live, the divorce decree should be irrelevant. Dependency will solely be determined on the other rules as listed in Pub. 501 without any regard to rules for children of divorced or separated parents, as those rules no longer apply.

So if son is living with dad and emancipated under state law, assuming the other conditions in Pub. 501 are met, dad would get the exemption and the college credits if his income is not too high.  However, he still would end up with some income from the 10099Q if he claims the credits.

[rbynaker]

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@Frustrated-in-IL wrote:

If the son is emancipated in the state where they live, the divorce decree should be irrelevant.

Great catch, I glossed over that part and focused on the education piece but you're absolutely correct.