It’s ironic that your post begins with “let’s be honest” and then suggests breaking the rules because “no one checks this.”
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I’m simply giving the reality.
As I noted I don’t do this. But had I never looked up the rule, I would have simply claimed what was spent - and I’m sure many do.
As noted I don’t have an issue if that’s what someone did.
Op can do as they want.
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The reality is that some people cheat on their taxes. Recognizing that reality and stating that you don’t have an issue with it are two very different things.
Unfortunately, tax laws and regulations in this country are way too complicated for those of us who are simply trying to comply with a civic responsibility. It doesn’t have to, and it shouldn’t, be this way. But the rules defining 529 qualified room and board expenses are not overly complicated. If you want to take advantage of the tax-free features of a 529 account, at least take a few minutes to understand what your obligations are.
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Particularly since as I understand it the recipient will be able to cover the room and board difference out of a taxed but not penalized scholarship offset. Normally that would still score as a pretty good tax deal overall anyway (assuming a pretty low marginal rate, possibly zero for some recipients). That’s going to require some additional tax work anyway (but not much), so it seems to me like just doing that tax work as documented by the school ($X for qualified expenses per the COA, $Y for the scholarship offset) is all of the legal, ethical, and practical thing to do.
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And for most kids in grad school- who likely don’t have 15 sources of income, K-1, dividends, etc. doing the tax work will take less than an hour. I’m not sure what the fuss is. The extra tax liability is likely to be close to zero.
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I think it’s the 10% penalty that’s the issue.
I believe in this case that was mooted:
This is now down to ideally wanting the school to characterize more of the gains portion (it doesn’t matter for the contribution portion) as for qualified COA (neither penalized nor taxed) versus scholarship offset (also not penalized but taxed at the recipient’s marginal rate). And that is not an unreasonable thought, but I think understood that way, it is likely a very low stakes issue.
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Not for this kid- she won’t have the penalty.
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Then like you all are saying, after standard deduction, there may not be any tax liability for dollar amounts withdrawn.
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That’s how I read the OP’s dilemma… an hour of time for the student to learn how to do a tax return! Unless there’s a Swiss bank account or she’s an active derivatives trader, or part-owner of a major league sports team… in which case multiply the one hour required to do the 529 return by about 500 hours!!!
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Re marginal rates, then assuming the standard deduction isn’t exceeded then I think this also avoids any issue of kiddie tax if this student is still under 24. But if you do incur taxes (because the taxable amount is more than $16K) then it is important to take this into consideration. We ended up making a deductible IRA contribution for D18 when her earnings plus taxable scholarship pushed her over the standard deduction one year during undergrad.
I think that the way to report it in a situation where kiddie tax might be an issue (ie the recipient is a full time student under 24) is to declare the tuition scholarship as taxable and (in your head at least) allocate the 529 money to tuition, not to report the 529 withdrawal as non-qualified and say there’s no penalty due to the scholarship waiver. Taxable scholarships count as earned income for the purposes of the standard deduction, whereas non-qualified 529 withdrawals are probably unearned income. Do I have this right @BelknapPoint ?
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Yes; allowing dependents when calculating their standard deduction to treat taxable scholarships as earned income can be a huge benefit to the taxpayer.
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