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• Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assis- tance. Taxable earnings. Use the following steps to figure the taxable part. 1. Multiply the total distributed earnings shown in box 2 of Form 1099-Q, by a fraction. The numerator (top part) is the adjusted qualified education expenses paid during the year and the denominator (bottom part) is the total amount distributed during the year. 2. Subtract the amount figured in (1) from the total dis- tributed earnings. The result is the amount the benefi- ciary must include in income. Report it on Schedule 1 (Form 1040), line 8z. Example 1. In 2013, Sara Clarke's parents opened a savings account for her with a QTP maintained by their state government. Over the years, they contributed $18,000 to the account. The total balance in the account was $27,000 on the date the distribution was made. In the summer of 2021, Sara enrolled in college and had $8,300 of qualified education expenses for the rest of the year. She paid her college expenses from the following sour- ces. Gift from parents . . . . . . . . . . . . . . . . . . . . $1,600 Partial tuition scholarship (tax free) . . . . . . . 3,100 QTP distribution . . . . . . . . . . . . . . . . . . . . 5,300 Before Sara can determine the taxable part of her QTP distribution, she must reduce her total qualified education expenses by any tax-free educational assistance. Total qualified education expenses . . . . . . $8,300 Minus: Tax-free educational assistance . . . – 3,100 Equals: Adjusted qualified education expenses (AQEE) . . . . . . . . . . . $5,200 Since the remaining expenses ($5,200) are less than the QTP distribution, part of the earnings will be taxable. Sara's Form 1099-Q shows that $950 of the QTP distri- bution is earnings. Sara figures the taxable part of the dis- tributed earnings as follows. 1. $950 (earnings) × $5,200 AQEE $5,300 distribution = $932 (tax-free earnings) 2. $950 (earnings) −$932 (tax-free earnings) = $18 (taxable earnings) Sara must include $18 in income (Schedule 1 (Form 1040), line 8z) as distributed QTP earnings not used for AQEE. Coordination With American Opportunity and Lifetime Learning Credits An American opportunity or lifetime learning credit (edu- cation credit) can be claimed in the same year the benefi- ciary takes a tax-free distribution from a QTP, as long as the same expenses aren't used for both benefits. This means that after the beneficiary reduces qualified educa- tion expenses by tax-free educational assistance, he or she must further reduce them by the expenses taken into account in determining the credit. Example 2. Assume the same facts as in Example 1, except that Sara's parents claimed an American opportu- nity credit of $2,500 (based on $4,000 expenses). Total qualified education expenses . . . . . . . . . $8,300 Minus: Tax-free educational assistance . . . . . . − 3,100 Minus: Expenses taken into account in figuring American opportunity credit . . . . . . − 4,000 Equals: Adjusted qualified education expenses (AQEE) . . . . . . . . . . . . . . $1,200 The taxable part of the distribution is figured as follows. 1. $950 (earnings) × $1,200 AQEE $5,300 distribution = $215 (tax-free earnings) 2. $950 (earnings) −$215 (tax-free earnings) = $735 (taxable earnings) Sara must include $735 in income (Schedule 1 (Form 1040), line 8z). This represents distributed earnings not used for AQEE. Coordination With Coverdell ESA Distributions If a designated beneficiary receives distributions from both a QTP and a Coverdell ESA in the same year, and the total of these distributions is more than the benefi- ciary's AQEE, the expenses must be allocated between the distributions. Example 3. Assume the same facts as in Example 2, except that instead of receiving a $5,300 distribution from her QTP, Sara received $4,600 from that account and $700 from her Coverdell ESA. In this case, Sara must allo- cate her $1,200 of AQEE between the two distributions. $1,200 AQEE × $700 ESA distribution $5,300 total distribution = $158 AQEE (ESA) $1,200 AQEE × $4,600 QTP distribution $5,300 total distribution = $1,042 AQEE (QTP) Sara then figures the taxable portion of her Coverdell ESA distribution based on qualified education expenses of $158, and the taxable portion of her QTP distribution based on the other $1,042. Chapter 7 Qualified Tuition Program (QTP) Page 53