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Question for the Money Doctors

Question submitted on Nov 12, 2021.

Question

I withdrew $2000 from 529 to pay for computer in July and now realize it’s a qualified expense I could use toward a tax credit on my income tax return. I still have a $7000 bill to pay the university so if I only withdraw $5000 can I still take advantage of the tax credit for 2021?

Answer

Great question.  The IRS recognizes that it's possible that the purchase of a computer for education can qualify for the American Opportunity Tax Credit (AOTC).  They do caution taxpayers to make sure to retain the documents needed to prove eligibility and the amount of the credit in case your return is selected for audit.  In IRS Publication 970 on Page 61, the IRS addresses how this credit is coordinated with tax-free withdrawals from 529 plans.  In fact, Example 2 on that page sounds like it is similar to your situation.  A taxpayer's qualified education expenses are reduced by the amount of the credit claimed.  Then, any distribution from a 529 plan (referred to as a "qualified tuition plan" or "QTP" by the IRS) is compared to the education expense as reduced by the AOTC credit.  If the 529 distribution is that amount or less, it will be completely tax-free.  If it exceeds that reduced education expense, a further calculation will be needed to determine how much of the excess needs to be added to the taxpayer's taxable income.  So in your case, if the computer purchase of $2,000 reduces your qualified education expense to $5,000, any distribution of that amount of less that you take from your 529 plan will be tax-free.  Thanks for a great question and good luck with your studies.    


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