Computation of Other Income Due to Taking American Opportunity Credit and Using 529 Plan

For 2012, I'm taking the $2500 American Opportunity Credit (AOC) for payment of >$4,000 college tuition/fees/books for my dependent child.

I used proceeds from my 529 college savings plans to pay these Qualified Educational Expenses (QEEs), as well as room and board.

Therefore per IRS Pub 970, Page 56, Example 2, I need to compute the taxable portion of gain from the distributions from the 529 plans for the $4000 toward taking the AOC, to apply as Other Income to my child's return.

The 1099-Q I assume will not separate how much of the total distribution and total gain was used toward tuition/fees/books, and how much was used toward room/board. Therefore I assume I'll have to prorate these amounts.

Please verify that my computational algorithm for computation of taxable gain is correct:

For a total distribution and gain on 1099-Q that covers tuition/fees/books/room/board, compute the prorated amount of distribution and gain for tuition/fees/books only (QEEs for use in taking the AOC), as the ratio of the amounts for tuition/fees/books to total.

The taxable gain due to taking the AOC is computed as:

$4000 x Prorated Gain (for tuition/fees/books only) / Prorated Distribution (for tuition fees/books only)

The numbers:

Total Distribution (tuition/fees/books/room/board): $15584 Total Gain (tuition/fees/books/room/board): $2334

Prorated Distribution (tuition/fees/books only): $5099 Prorated Gain (tuition/fees/books only): $761

Taxable Gain due to taking AOC: $4000 x $761 / $5099 = $597, reported on child's return as Other Income

Correct?

I'm not sure what you are saying here, but see below.

Nothing needs to be prorated by the taxpayer.

See below for the calculation when there is an AOTC and a QTP distribution.

I have no idea if you arrived at the correct answer by chance because you did not follow the formula in the IRS Pub you reference.

Assuming you maxed out the AOTC with $4000 of qualified expenses.

1.Calculate the amount of qualified expenses for a QTP by adding up ALL the qualified expenses for a QTP. This includes the applicable amount spent on allowable room and board as defined in Pub 970 plus all the other normal qualified expenses such as tuition, fees, books, etc. (Effectively, this is the same definition as used for the AOTC plus room and board.) Let's assume that comes to $18,000 including the allowable room and board.

Subtract from the above any amount of scholarships received and subtract the amount of expense you used for the AOTC to arrive at the Adjusted Qualified Expenses (AQE) for the QTP distribution. Let's assume there were no scholarships, so we subtract 00 from ,000 to arrive at an AQE of 000 for a QTP.
Determine the amount of earnings that are tax free by multiplying the earnings from Box 2 of the 1099-Q by the AQE and dividing by the QTP distribution (Box 1 of the 1099-Q). Let's assume the earnings in Box 2 are 1 and the distribution in Box

1 is $15,584. $761 x $14000/15584 = $684 tax-free.

Subtract the result of Step 3 from the earnings in Box 2 of the

1099-Q to arrive at the taxable amount to be reported on the child's 1040 Line 21. $761 - $684 = $77 of taxable income.

The above is the exact formula used in Example 2 in the IRS pub. There are no prorations of any kind to be made by you.

You can quickly see from the above example, that there would not be any taxable amount as long as the total QTP qualified expenses are at least $4000 more than the QTP distribution.