529 Plan Distribution and American Opp. Credit

[Dave T]

I’m probably not thinking clearly on this and wondering if someone might be able to shed some light on what I’m missing.

Parents take a distribution from their 529 plan (QTP) to pay for college expense for son.

Here is the breakdown on the 1099-Q Total Distribution $ 19,800. Earnings - $ 6,618 – Basis $ 13,182.

Here are the expenses – Room & Board - $ 9,215, Tuition, fees and books net of scholarships - $ 7,166= total expenses of $ 16,381.

I’ve calculated the tax free and taxable portions of the distribution as follows:

$ 6,618 x 16,381/19,800

• Tax Exempt $ 5,475
• Taxable 1,143

Where I’m getting hung up is whether they can still take the American Opp. Credit. I’m trying to follow the example in Publication 970 and this is how I’m figuring it:

Net Tuition, Fees and Books $ 7,166 less $ 4,000 allowable for computing credit = $ 3,166.. I believe I then need to again compute a taxable and non taxable portion as follows:

6,618 x 3,166/19,800

Tax Exempt – $ 1,059

Taxable 5,559

If my calculations are correct, and I’m not entirely sure at this point, they would probably be better off by not taking the credit.

I apologize for throwing a lot of numbers out there and also for being obtuse about this but I’m trying the best I can for this new client and help mitigate what is already a rather large amount due.

Thanks for your assistance.

[HV Ken]

From memory, take the AOC and instead subtract the AOC benefit in the taxable calculation on the 1099-Q distribution. The savings from AOC should be way better than paying a little more tax on the excessive distribution from the 529 plan.

[Randall]

I agree that usually it would be better to take the AOC first if they qualify for it. But I don't think you can just deduct the credit amount and use the balance to calculate the 529 taxable portion. You have to use the cost amount ($4000) used for the AOC, then the remaining cost balance applied toward the 529 calculation. Room and board won't count for AOC but does for 529.

[Cathy]

From memory, take the AOC and instead subtract the AOC benefit in the taxable calculation on the 1099-Q distribution. The savings from AOC should be way better than paying a little more tax on the excessive distribution from the 529 plan.

The calculations on a 529 Plan will drive you nuts (be sure to include your final calculation breakdown in the original return or you will regret it in a couple of years when your client gets a letter telling her she didn't pay enough taxes). You have to figure it both ways to see how your client comes out. There can be other issues that the figures might affect such as the EIC, Child Tax Credit, etc..., therefore, you just have to see which produces the best tax liability for your client....I think the last one I did, it worked out better by taking a partial AOC credit.

Good luck!

Cathy

P.S. The reason I suggest for you to send a breakdown of your calculation with the original return is that if you wait, not only will you have to send in the calculation, but you will be instructed to also send in all receipts, etc...