Education Credits Priority Order/1099-Q taxable

[JohnHMartin]

Hello,

1. If I opt to not use American Opportunity Credit (AOC) but otherwise have undergrad student entered in Student Info and applicable expenses via 1098-T, will I lose one of the four years allowable to claim AOC? The first year student has only $229 out of pocket after scholarship at junior college in 2019 but I'm thinking the student will need four or more calendar years pursuing bachelor degree going forward 2020 onward and eventually at university where potential credits are larger due to higher tuition and maybe less in scholarships. So why not use Lifetime Learning (LLC) in 2019?

2. The parent here withdrew from 529 savings plan more than the $229 needed above so the gain of $479 on this distribution is taxable though without penalty. The no penalty is due to the AOC covering the $228 out of pocket. In ProSeries when I change my 'Education Costs Optimizer' page choice from automatic (chooses AOC) to manual (using LLC which is 20% of $229 at $46, $183 less), the entire $479 529 gain remains taxable without penalty. 

Shouldn't the taxable portion of the 529 gain reduce by $183 reduction in credit I'm opting for? I also set the manual choice to no credits and the same $479 gain remains taxable.

Which begs the question, am I losing one of four AOCs if I don't use it here AND does the 529 distribution gain remain taxable as if the AOC was applied even if I chose not to use it?

There are not a lot of $ here but I'm more curious regarding my interpretations being correct or not.

Thanks to anyone who read to this point! 

[rbynaker]

The software is powerful but can be quirky in this area.  I'll respond generally but there may be things you'll need to fiddle with in data entry to get the correct outcome.

You can claim AOTC on up to 4 years of tax returns as long as the student is an undergrad at the beginning of the tax year.  Sounds like in your case you want that to be years 2-5 instead of the usual 1-4.  That's fine.

On the 529 distribution, pay attention to the 1099-Q recipient.  Sometimes this is Mom & Dad, sometimes this is Junior.  The income is taxable to the recipient.  In contrast, the education credits follow the dependent.  So presumably Mom & Dad will claim Junior and his education credit, but Junior might have to file a return if he was the recipient of the 529 money.

In terms of penalty on the 529 money, it's probably the scholarship that's preventing the penalty (not anything having to do with the credit) but you have to manually cross reference between the 1098-T worksheets and the 1099-Q worksheets to get the taxable amount correct.  So make sure your 1099-Q Wks knows that you've already used education expenses for the Lifetime Learning Credit.  Also, keep in mind there are different rules.  So the 529 money could be used for room & board or a computer and still be tax free while not taking away any qualifying expenses for your education credit.

Are we having fun yet?

Rick

[JohnHMartin]

Thank you Rick, I found where to make this entry. It is Dependent Student Info Worksheet Part VIII, line 2h where I had to manually enter the Adjusted Qualified Expenses applied. Otherwise, it populates as zero thinking the entire Qualified Expense was covered by AOC despite me opting out of AOC.

By doing so the taxable amount of the 529 gain was lowered proportionally to the amount of distribution that was qualified expenses. In this instance 13% of the gain was reduced while 87% remain taxable.

Is this what you would expect?

Thank you. Every dollar helps!

[rbynaker · Accepted solution]

You really just have to run the numbers manually and see what works out best.  If there's AOTC you're hard pressed to find anything better, so usually that's a no-brainer.  But in this case, I agree it would be a waste to use up 1 of the 4 years of AOTC on such a small amount.  So you're left probably juggling T&F deduction, LLC and the tax on the 529 income.  That's going to vary by tax brackets (and possibly AGI limits).

You might be able to "fake" the optimizer into giving you the best choice between T&F and LLC by deliberately disqualifying AOTC.  But, to my knowledge, there's no way for ProSeries to factor taxable 529 plan into the optimization.  So any way you slice it, you're running scenarios and jotting the tax amounts down on a scrap of paper.  Sometimes state taxes come into play as well.  Here in VA, the T&F deduction will reduce VA tax but we have no education credits.  So sometimes T&F will result in a higher federal tax but reduce the VA tax by more than enough to offset.

[ivlabonne]

In Pro series could you tell me how to opt out of the AOTC? Taxpayer has taxable income from the 1099Q if I take the AOTC. Taxpayer only gets $1205 out of $5,000 for 2 students due to making 170k

so if I don't take the AOTC, he can use all the 1099Q with no tax.overall saving him about $800

help

Irene