The IRS disallows “double-dipping,” which means utilizing more than one tax benefit on the same expenditure. For example, a taxpayer cannot take both the American Opportunity Tax Credit (AOTC) and the Lifetime Learning Credit (LLC) for themselves, or for the same dependent, in the same tax year.

Also, for example, if a taxpayer spends money on tuition and is able to claim one of the education credits, then those same tuition costs cannot be used to offset a Qualified Tuition Program (529 plan) distribution to make it nontaxable. Distributions from a 529 fund in excess of Qualified Higher Education Expenses (QHEE) are considered taxable income to the extent the distribution exceeds the basis in the fund. As such, any QHEE expenses used to calculate the AOTC cannot also be used to calculate the nontaxable portion of the 529 distribution.

QHEE includes any amounts paid for tuition, fees, books, supplies, or any related expense required for attendance at a postsecondary institution by an eligible student who is enrolled at least half-time. Necessary books, supplies, and equipment for a class are qualified, even if these expenses are not paid directly to the school. However, they must be paid directly to an eligible education institution for the LLC.

Here’s your planning opportunities: first, room and board expenses are only considered qualified for the 529 plan distributions, and not AOTC; second, only the first $4,000 of QHEE are needed to qualify for the AOTC. As such, use the 529 plan funds for all room and board and any tuition and QHEE in excess of $4,000.

All of these expenses must be paid for an academic period that begins during the tax year, or the first three months of the following year. QHEE can be paid by cash, check, credit card, or loans. If paid with money from a loan, the expenses qualify in the year you actually make the education-related payment, not the year you obtain or repay the loan. You must reduce QHEE by any amount paid with tax-free grants and scholarships. The AOTC can still be claimed in the same year that a tax-free 529 distribution is made, as long as there are enough expenditures to calculate both separately. A taxpayer will want to determine which option is most advantageous to them in each applicable tax year. Generally, a tax credit that increases a refund or decreases any tax due is better than solely reducing taxable income. Contact your tax professional at Ketel Thorstenson, LLP if you have any questions.