Dave received a 1099-Q for a distribution that he received from his QTP. His gross distribution (box 1) was $5000 and his earnings (box 2) were $1500. Throughout the year, he paid qualifying expenses totalling $8000.
Option 1: To exclude his earnings ($1500) from being included in his income, Dave chooses to report his information as follows:
What he enters: When entering his 1099-Q, he enters his distribution and earnings in the appropriate fields. For qualified expenses paid with his 1099-Q distribution, he enters $5000. He is indicating that the full distribution went towards qualifying education expenses. Dave chooses to use the remaining expenses that he paid out-of-pocket ($3000) as a Tuition and Fees Deduction.
The result: On Dave's return, none of his QTP earnings are included as Other Income on line 21. He also receives a Tuition and Fees Deduction of $3000 on line 34.
Option 2: Dave would rather use the full amount of his expenses towards an Education Credit, and go ahead and include the earnings from his QTP ($1500) as income.
What he enters: When entering his 1099-Q, he enters his distribution and earnings in the appropriate fields. For qualified expenses paid with his 1099-Q distribution, he enters $0. He doesn't want to use any of his expenses to exclude the 1099-Q earnings from his income. However, because the earnings were used for education expenses, they are not subject to the usual 10% penalty. To exclude these earnings from the penalty, he goes into Other Taxes > Tax on Early Distribution and enters the earnings in the field for: Coverdell ESAs and QTPs that are not subject to the additional tax. When entering his Education Credit, for Qualified Expenses, he enters the full $8000 to receive a larger education credit.
The result: On Dave's return, his QTP earnings are reported as income on line 21 as Other Income. Because all of his expenses were allocated to his Education Credit, he receives a much larger Education Credit on line 49. Because he filled out Form 5329, no additional tax penalty is calculated on line 60.
For further information, please review Form 1099-Q.