Tuition last year was $45K, $30K was paid by 529 withdrawals paid directly to the school. I control the 529, but the 1099-Q was in daughter's SSN
Daughter earned roughly $9K in summer job and had some taxes withheld.
We would not claim her anyway on 1040, since we are beyond exemption phaseout.
I tried to compute the support test to see if she paid 1/2 of her own support and it all comes down to whether the 529 withdrawal was her own support.
I've been reading opinions on the web, and they vary. This is apparently an unsettled issue (or is it?). Fortunately in her case, the decision doesn't change her tax liability - it's zero anyway.
If she is considered to have paid her own support, then she gets an exemption, which eliminates all of her taxes, and she gets a full refund of her withholding.
If she is considered not to have paid her own support, she gets the American Opportunities Tax Credit (AOTC) which eliminates all of her taxes, and she gets a full refund of her withholding.
This is only the 2nd year she would be claiming the AOTC. She is graduating in 2014, so it doesn't affect her AOTC eligibility for 2014 anyway.
The only difference I can see is whether or not I can claim her for Massachusetts tax purposes, which I could have if she didn't provide more than 1/2 of her own support. If I don't claim her, it only costs me $105 because I lose the state exemption.
Her tuition is deductible for Massachusetts state taxes, so she gets a full refund of state taxes whether or not she claims a state exemption. If I don't claim one, she can.
I'm trying to be safe.
What I'm thinking of doing is not claiming her for state taxes, and taking the position that she did provide more than 1/2 of her own support and having her take the exemption, but submitting form 8863 anyway showing that she is eligible for a non-refundable tax credit, which turns out to be zero because she doesn't owe any taxes anyway. I figure that if someone questions whether or not she was allowed to take the exemption, then at least she filed the 8863 showing her eligibility to eliminate her federal taxes from the AOTC. I hope this would dissuade someone from asking since it won't result in any more taxes.
Since the implementation of the qualifying child rules in 2005, IRC Sec.
152 regulations have not been updated. The issue on who is the contributor for a QTP distribution has never been answered by the courts as far as I can tell. Here is analysis of the subject from the AICPA. Basically, an argument can be made it is the student and an argument can made it is the owner of the QTP.
Student: He is the one that must declare any taxable portion of the distribution.
Owner: He controls the account and determines who gets the money.
Student: Under Gift & Estate rules, contributions are a completed gift to the beneficiary. Additionally, under the change in beneficiary rules, the old beneficiary is the transferor.
So.... know one knows whether the self-support test includes QTP distributions as being provided by the student or the owner.
Personally, I lean to who is in control. The owner can change the designated beneficiary. The owner may avoid naming a beneficiary and receive the funds himself.
======================================================================= Under Regs. Sec. 1.152-1(a)(2)(ii), any amount contributed by an individual for his or her support is considered, including income that is ordinarily excludable from gross income. Since the student is taxed on the distributions from the QTP or the distributions are excluded from the student?s gross income, the regulation supports the position that the QTP funds (total distributions from the Sec. 529 plan) are contributed by the student for his or her support.
The other line of reasoning is that the account owner retains control over the funds, including the withdrawal of the assets from the QTP. According to Prop. Regs. Sec. 1.529-1(c):
Account owner means the person who, under the terms of the QSTP or any contract setting forth the terms under which contributions may be made to an account for the benefit of a designated beneficiary, is entitled to select or change the designated beneficiary of an account, to designate any person other than the designated beneficiary to whom funds may be paid from the account, or to receive distributions from the account if no such other person is designated. Typically a parent or grandparent is the account owner, but anyone can set up a QTP for either a related or an unrelated individual. The argument could be made that because the account owner controls whether a distribution is made and the amount of the distribution, and can even withdraw funds for himself or herself, the distribution from a QTP should be considered provided by the account owner for purposes of the support test. However, the estate and gift tax treatment of QTPs discussed below supports the position that the student should be treated as the person providing the support.
[skipped content] From a gift and estate perspective, Sec. 529(c)(2) provides that contributions to QTPs are treated as completed gifts of a present interest to the plan beneficiary when the money is contributed to the plan, making the contribution eligible for the annual gift tax exclusion. By treating the contribution as a completed gift, generally no amount of the QTP is included in the gross estate of the account owner.18 However, if the donor elects to treat the contributions to a QTP as made over a five-year period and dies within that five-year period, the portion of the contribution allocated to the period after death is included in the donor?s estate.19
.... completed gift treatment at the time of contribution weakens the argument that the funds belong to the account owner for purposes of the support test, even though the owner still has unrestricted control over the funds in the QTP.
The estate and gift tax treatment of a change in beneficiaries follows the completed gift treatment of the contribution, providing additional support for the position that QTP distributions will be treated as funds provided by the student. Prop. Regs. Sec. 1.529-5(b)(3) states that a transfer which occurs by reason of a change in the designated beneficiary, or a rollover of credits or account balances from the account of one beneficiary to the account of another beneficiary, will be treated as a taxable gift by the old beneficiary to the new beneficiary if the new beneficiary is assigned to a lower generation than the old beneficiary.
Treating the ?old beneficiary? as the transferor for gift tax purposes supports treating the student as the provider of the QTP funds for purposes of the support test.
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