Question

Phil's qualified education expenses for the year are $34,000. He claims a $2,500 American Opportunity Credit (based on $4,000 of his expenses). If Phil receives a $40,000 ESA distribution that includes $4,000 in earnings, how much of the entire ESA distribution will he receive tax-free?

Answer 1

Phil will receive $36,000 of the entire ESA distribution tax-free.

Step-by-step explanation:

To determine how much of the entire Education Savings Account (ESA) distribution Phil will receive tax-free, we need to consider the rules and limits for the American Opportunity Credit (AOC) and qualified education expenses. The AOC allows Phil to claim a tax credit of $2,500 based on $4,000 of his expenses. However, the AOC cannot be claimed for the same expenses used to determine the tax-free portion of the ESA distribution. Since Phil's qualified education expenses for the year are $34,000, $4,000 of which is used for the AOC, we subtract $4,000 from the total ESA distribution of $40,000 to get $36,000. This $36,000 is the amount of the ESA distribution that is subject to taxation.

Therefore, Phil will receive $36,000 of the entire ESA distribution tax-free.