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1. $850 (distribution) × $1,500 basis + $0 contributions $950 value + $850 distribution = $708 (basis portion of distribution) 2. $850 (distribution) −$708 (basis portion of distribution) = $142 (earnings included in distribution) 3. $142 (earnings) × $700 AQEE $850 distribution = $117 (tax-free earnings) 4. $142 (earnings) −$117 (tax-free earnings) = $25 (taxable earnings) You must include $25 in income as distributed earnings not used for qualified education expenses. Report this amount on Schedule 1 (Form 1040), line 8z, listing the type and amount of income. Worksheet 6-3, at the end of this chapter, can help you figure your AQEE, how much of your distribution must be included in income, and the remaining basis in your Cov- erdell ESA(s). Coordination With American Opportunity and Lifetime Learning Credits The American opportunity or lifetime learning credit can be claimed in the same year the beneficiary takes a tax-free distribution from a Coverdell ESA, as long as the same expenses aren't used for both benefits. This means the beneficiary must reduce qualified higher education ex- penses (QHEE) by tax-free educational assistance, and then further reduce them by any expenses taken into ac- count in determining an American opportunity or lifetime learning credit. Example. In 2022, during your first year in college you had $5,800 of QHEE. You paid your college expenses from the following sources. Partial tuition scholarship (tax free) . . . . . . . . . $1,500 Coverdell ESA distribution . . . . . . . . . . . . . . . 1,000 Gift from parents . . . . . . . . . . . . . . . . . . . . . . 2,100 Earnings from part-time job . . . . . . . . . . . . . . . 1,200 Of the $5,800 of QHEE, $4,000 was tuition and related ex- penses that also qualified for an American opportunity credit. Your parents claimed a $2,500 American opportu- nity credit (based on $4,000 expenses) on their tax return. Before you can determine the taxable portion of your Coverdell ESA distribution, you must reduce your total QHEE. Total QHEE . . . . . . . . . . . . . . . . . . . . . . . . . $5,800 Minus: Tax-free educational assistance . . . . . . − 1,500 Minus: Expenses taken into account in figuring American opportunity credit . . . . . . . − 4,000 Equals: Adjusted qualified higher education expenses (AQHEE) . . . . . . . . . . . . . . . . . . . $ 300 Since the AQHEE ($300) are less than the Coverdell ESA distribution ($1,000), part of the distribution will be taxa- ble. The balance in your account was $1,800 on Decem- ber 31, 2022. Prior to 2022, $2,100 had been contributed to this account. Contributions for 2022 totaled $400. Using the four steps outlined earlier, you figure the taxable por- tion of your distribution as shown below. 1. $1,000 (distribution) × $2,100 basis + $400 contributions $1,800 value + $1,000 distribution = $893 (basis portion of distribution) 2. $1,000 (distribution) −$893 (basis portion of distribution) = $107 (earnings included in distribution) 3. $107 (earnings) × $300 AQHEE $1,000 distribution = $32 (tax-free earnings) 4. $107 (earnings) −$32 (tax-free earnings) = $75 (taxable earnings) You must include $75 in income (Schedule 1 (Form 1040), line 8z). This is the amount of distributed earnings not used for AQHEE. Coordination With Qualified Tuition Program (QTP) Distributions If a designated beneficiary receives distributions from both a Coverdell ESA and a QTP in the same year, and the total distribution is more than the beneficiary's AQEE, those expenses must be allocated between the distribu- tion from the Coverdell ESA and the distribution from the QTP before figuring how much of each distribution is taxa- ble. The following two examples illustrate possible alloca- tions. Example 1. In 2022, you graduated from high school and began your first semester of college. That year, you had $1,000 of qualified elementary and secondary educa- tion expenses (QESEE) for high school and $3,000 of QHEE for college. Your QESEE doesn't include tuition. To pay these expenses, you withdrew $800 from your Cover- dell ESA and $4,200 from your QTP. No one claimed you as a dependent, nor were you eligible for an education credit. You didn't receive any tax-free educational assis- tance in 2022. You must allocate your total qualified edu- cation expenses between the two distributions. 1. You know that tax-free treatment will be available if you apply your $800 Coverdell ESA distribution to- ward your $1,000 of qualified education expenses for Page 46 Chapter 6 Coverdell Education Savings Account (ESA)