Based on the available information, it is concluded that Phil will receive $8,500 of the entire ESA distribution tax-free, and the remaining $31,500 will be taxable.
To determine how much of the entire ESA (Education Savings Account) distribution Phil will receive tax-free, consider the qualified education expenses and the earnings portion of the distribution.
In this case, Phil's qualified education expenses for the year are $34,000, and he claims a $2,500 American Opportunity Credit based on $4,000 of his expenses. This means that $2,500 of his expenses will be covered by the credit.
Now, let's calculate the taxable portion of the ESA distribution:
Total ESA distribution = $40,000
Earnings portion of the distribution = $4,000
Since Phil's qualified education expenses ($34,000) exceed the amount covered by the American Opportunity Credit ($2,500), the remaining qualified education expenses that are not covered by the credit are $34,000 - $2,500 = $31,500.
To determine the taxable portion of the ESA distribution, subtract the remaining qualified education expenses from the total ESA distribution:
Taxable portion of the ESA distribution = Total ESA distribution - Remaining qualified education expenses
Taxable portion of the ESA distribution = $40,000 - $31,500
Taxable portion of the ESA distribution = $8,500
Therefore, Phil will receive $8,500 of the entire ESA distribution tax-free, and the remaining $31,500 will be taxable.