Am I Doing This Correctly?

Financial Planning Tax Strategies
1

I’m working on my 2023 income taxes in TurboTax. 2023 is the first tax year where I’ve had to deal with 529 reimbursements for expenses. (The school my son attends charges a fee for direct 529 payments, so it’s cheaper for me to pay the school directly and then reimburse myself from the 529).

Using round and simplified numbers, let’s say his total fall semester of 2023 cost $18,000. $8,000 was tuition, $7,000 was room and board, $2,000 was a laptop and course-mandatory software, $600 was textbooks, and $400 was mandatory fees.

Of that $18,000, my son got $10,000 worth of it covered by scholarships, leaving me to pay $8,000 out of pocket. I believe all $8,000 would qualify as a 529-eligible expense, and at least when I put everything into TurboTax, it did not change my tax owed amount vs. where it was before I started working on the college topic.

That said, TurboTax is indicating that when we get to his taxes, my son will need to treat $2,000 of his scholarship as taxable income because it went towards room and board, not tuition.

Did I enter that part in TurboTax correctly? Or are there other expenses from the list above that we could apply the scholarship money towards that would not result in it showing up as taxable income to him? From the Bursar’s Bill perspective, tuition, room, board, fees, and most of his textbooks were directly charged on the same bill.

Thanks in advance for your guidance.

Regards,
-Chuck
Home Fool

2

From IRS Pub 970 p970.pdf (irs.gov)

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so it looks like there should be enough qualified expenses to apply to his scholarship for the entire scholarship amount to be tax-free. However, if you count the expense toward his scholarship, then it can’t be used again to make a tax-free 529 withdrawal.

Later in Pub 970, there is a whole section on 529 plans (aka QTPs) which says that room are board are qualified education expenses for 529s. Since room and board is a qualified expense for a 529 withdrawal, but is not a qualified expense for a tax-free scholarship, you need to be sure that Turbo-Tax is clear that you are using the 529 withdrawal for room and board, not the scholarship money. You also need to be sure that the documentation that the college provided shows that the room and board was paid for by money that you paid, not money that the scholarship paid. If the documentation that the college provided shows that the scholarship paid for $2,000 of his room and board, then it will be taxable to him.

I would also point out that even though he got a scholarship, you can take the full $18k out of the 529. The scholarship amount of $10k would be taxable at ordinary income rates, but you won’t be charged the 10% penalty because you are taking out the scholarship amount.

AJ

3 Likes
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Thanks, AJ — I will update TurboTax to reflect that reality.

That’s good to know for the future, but there will not be enough in his 529 to cover four years of school if I were to withdraw at that rate.

Regards,
-Chuck
Home Fool

4

So I re-ran the numbers, and TurboTax is still showing him as having to report a portion of the scholarship money as taxable. (Less than before, but still a portion of it).

As near as I can tell from following the worksheet in forms mode, it appears to be the laptop that’s triggering the taxable amount. This webpage indicates that a laptop is required for his program: Laptop Requirement | University of Cincinnati .

Is there some question I need to answer differently or some flag I should flip in forms mode? Or is this legitimately taxable to him?

Regards,
-Chuck
Home Fool

5

Well, it looks like the school does require it, so my guess is that you need to answer a question in TurboTax differently. What question that would be I’m not sure, because I don’t use TurboTax. You could also see if you could figure out how to override the interview process and fill out the form directly.

AJ

2 Likes
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Thanks, AJ – I’m trying to make it work, but I’m not seeing any flag on the form that would let me mark it as a mandatory expense for his program. I’ll keep plugging away at it. I do appreciate the guidance.

Regards,
-Chuck
Home Fool

1 Like
7

Yes, but if you’re going to get to the point where, because of the scholarship, there’s too much in the account for it all to be tax-free, it’s good to have the ability to withdraw some without paying a penalty. And it wouldn’t have to be all $10k this year - you could withdraw an extra, say, $1k a year, which wouldn’t impact your taxes very much, but would also not leave you with an extra $4k - $5k (depending on growth) to be counted in your income in his final year, or worse, having to pay the penalty if you want to close out the account.

I would also point out that under current law, the rates will increase in 2026, so taking out taxable money in or before 2025 could be cheaper. You also don’t have to spend the extra money you take out on something other than his education - putting it into a taxable account to use for his education expenses in future years would be an option.

Of course, you could always leave the money in the account to pay for another child, if you have one. Or for grad school for this kid. Or for future grandkids.

AJ

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He’s my oldest of four, and right now, I’m more worried about having enough to cover across all four of them than I am about ending up with too much.

My third child has expressed interest in joining the military. If he goes that route, I’ll be encouraging him to either try for one of the service academies or to sign up for ROTC. If that is what he ends up doing, then I might end up with a surplus across the 529 plans. Otherwise, my oldest’s is going to end up really close, my second child’s would cover a couple of schools on her list (after scholarships), but not all of them, and the youngest is too far away for any projection to be more than a SWAG.

If there is a left over amount when all is said and done, there’s grad school, the next generation, and/or the new ability to put some money towards a Roth IRA from a 529. If it gets to the point where the best use of the money is to take it out to give back to myself for one reason or another, then I’ll cross that bridge when I get there.

There are just so many unknowns. For my oldest for instance, I’m learning that the school’s “hold costs flat” promise is worthless when it comes to housing. There’s such a shortage of on-campus housing that he’ll be forced to live off campus as a sophomore (and likely beyond). While we were forecasting a modest surplus in the 529 based on a late-breaking scholarship and that hold flat promise, with off-campus housing costs, that surplus is now vanishing.

He has a nice place lined up for next school year, but the price is about $2,000 a year more than the dorm cost. And yes, he could have gotten a cheaper place, but this one is right off campus in a safe neighborhood. Not all areas around campus are safe, and I’d rather have him close to school and safe instead of in a lower cost area that’s “cheaper for a good reason.” And yes, the school’s cost of attendance web page shows a higher price for off-campus housing, right about in line with that $2,000…

Basically, the surprise surplus from that late-breaking scholarship stayed in the 529 plan in order to cover the increased housing costs he’ll face next school year. Beyond that, we’ll figure it out as we go, but it’s way too early to say that we’re at a spot where withdrawing more than is strictly needed is the right approach…

Regards,
-Chuck
Home Fool

9

Just be sure that what you claim for the 529 doesn’t exceed the what the school shows in their cost of attendance, because costs in excess of that are not qualified expenses, even if they are your actual expenses. Again from Pub 970:

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AJ

1 Like
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Thanks. Based on the posted 2023/2024 costs, he should be ok, unless the off-campus meal plan costs spike next school year and do not get reflected in the published costs of attendance for some reason.

Regards,
-Chuck
Home Fool

11

Closing the loop on the original topic:

In the student’s tax return, the instructions in TurboTax indicate to include the computer cost in with the “books and materials” list of expenses if it’s required for the program. This is different from the parent’s tax return, where the computer was called out as a separate line item in the interview questions.

Because a computer is required for his program, I included it in the list.

Thanks for all your help.

Regards,
-Chuck
Home Fool