Hope Credit and taxable 529 withdrawals



It seems to me that some taxpayers might find themselves in a
particular position to use the Hope Credit to escape from looming
taxes and penalties for 529 withdrawals.

If you found yourself with excess funds in a 529 account (say the
older child didn't attend college as planned) and your younger child
is using the funds currently for college. However, you will have
ample excess funds in the 529, and will be ultimately required to
withdraw the funds, pay income tax on the earnings and pay a 10%
additional tax.

Why doesn't the taxpayer elect NOT to claim the child as an exemption,
withdraw 100% of the excess funds from the 529 in the student's name,
and use the Hope Credit to offset all of the tax on the 529
withdrawal? It sure looks to me like the income tax - and the
additional 10% tax - on the 529 can simply be offset by the Hope
Credit. (This assumes that the child pays the income tax on the 529

Is this a "get out of jail free" card for some folks? I realize not
many people fall into this particular situation, but it sure seems to
work from what I can tell.

Am I missing anything? (My children are just starting college so this
doesn't apply to me, but this new Hope Credit and the 529 account have
me thinking about the best uses of both.....)

Best wishes.




Alan said:
The 10% tax shows up on Line 59 of the 1040. The education credit shows
up on Line 50. Ergo, the credit can not shelter the 10% tax. The only
credits that can shelter early withdrawal penalties are refundable credits.

In the case where a parent can't get the benefit of the higher ed. tax
benefits (income is too high), then for sure the child should grab the
income and use the the credit to offset as much tax as possible.
In reviewing this reply, I realized it related to the Hope Credit
and not the The American Opportunity Tax Credit. The new credit
is 40% refundable as long as the taxpayer is not a child subject
to the "Kiddie Tax."

So.. you have to crank the numbers to see the result.

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