Is a child's return generated automatically if child owes taxes?

[dyons]

Hello all:

I am using TT for the first time and am told, in the section dealing with education credits, that my dependent child owes a few thousand dollars of taxes. (This is due to the excess of 529 distribution over qualified higher education expenses.)

I did not find any prompt that asks me if I want to create a tax return for my child for that income. Hence my questions:

(1) Is there an automated way by which TT creates a return for the child with the appropriate amount of taxable income populated in the right place?

OR

(2) Do I have to create a new tax return for the child. If so, how is the data from my form on the child's taxable amount linked to the child's tax return? Or do I have to copy that in manually, and find the appropriate place to add it?

Any help would be much appreciated.

Thanks in advance.

[Carl]

Hi Dyons,

 Welcome aboard! First, let me provide some clarification on a few things so you know where I'm coming from.

This is a public user-to-user forum. A vast majority of posts and responses you see here are from other users. I myself am "just another user" same as you and have been using TTX for about 13 years (give or take) now.  For a fist time user of the program I always recommend they use the CD/Desktop version of the program that they install on their computer. Compared to the online version of the program, the CD/Desktop version is significantly more user friendly, easier to navigate, and has some features (such as forms view) which is not possible with the online version. Now lets get to your questions.

With the online version of TTX, one account, one tax return. Period. If you create a 2nd tax return for the same tax year in the same account as the first tax return, then that first tax return is over written permanently and lost forever with no possibility of recovery. But you can create up to 5 accounts per e-mail address when using the online version. The only drawback with the online version is that you will pay big time, for each federal tax return you prepare, each state tax return you prepare, and each state tax return that you e-file. it can get expensive if you have others in your household (such as working teenagers) that need to file a tax return.

With the CD/Desktop version of the program that you physically install on your computer, you pay for the federal program ONE TIME, and you can use it to prepare an unlimited number of federal tax returns. However, per IRS rules you can only e-file a maximum of 5 federal returns with the IRS. Anything after that has to be printed, signed and mailed to the IRS.

Then if you need to complete a state return, you pay a purchase price for that state return ONE TIME. Then you can complete as many state returns for the state purchased, as desired. Then you will pay an additional fee for each state return e-filed. But with the CD/Desktop version you can chose to print, sign and mail the state return and there's no additional charge for that. So for most, not only in the Cd/Desktop version of the program easier and more user friendly, it's also significantly cheaper if you will be completing multiple returns in your household. (As you will be in your household.)

Now, if your college student is required to file a tax return then they will prepare their own return, just like you are preparing your own return. So if using the online version, you'll be paying for the federal program twice. Then if a state return is involved, you'll also be paying for the state program twice. I just want you to be aware of this stuff.

Now for your specific tax situation, please read the below carefully. If you need clarification on anything I'm happy to provide. The best thing to do is to print out the below and read it through once. Then read it through a 2nd time marking a line through anything that does NOT apply to you and your situation. Then read it through the third time ignoring what you marked out, and understanding it will be significantly easier then.

College Education Expenses

Colleges work in academic years, while the IRS works in calendar years. So the reality is, it takes you 5 calendar years to get that 4 year degree. With that said:

 - Scholarships and grants are claimed/reported as taxable income (initially) in the year they are received. It does not matter what year that scholarship or grant is *for*

- Tuition and other qualified education expenses are reported/claimed in the tax year they are paid. It does not matter what year they pay *for*.

Understand that figuring out who claims the student as a dependent, and determining who claims the education expenses & credits, is two different determinations. It depends on the specific situation as outlined below. After you read it, I have also attached a chart at the bottom. You can click on the chart to enlarge it so you can read it. If it’s still to hard to read on your screen then right-click on the enlarged image and elect to save it to your computer. Then you can double-click the saved image file on your computer to open it, and it will be even easier to read.

Here’s the general rules gisted from IRS Publication 970 at http://www.irs.gov/pub/irs-pdf/p970.pdf Some words are in bold, italicized, or capitalized just for emphasis. This is because correct interpretation by the reader is everything. Take the below contents LITERALLY, and do not try to “read between the lines”. If you do, you’ll interpret it incorrectly and risk reporting things wrong on your taxes. For example, there is a vast difference between “can be claimed” and “must be claimed”.  The first one indicates a choice. The second one provides no choice.

Now there are two separate determinations to be made here.

1. Who claims the student as a dependent.
2. Who reports all the education expenses and claims all the education credits.

First, who claims the student as a dependent?

If the student:

Is under the age of 24 on Dec 31 of the tax year and:

Is enrolled in an undergraduate program at an accredited institution and:

Is enrolled as a full time student for one academic semester that begins during the tax year, (each institution has their own definition of a full time student) and:

the STUDENT did NOT provide more that 50% of the STUDENT’S support (scholarships/grants received by the student ***do not count*** as the student providing their own support)

Then:

The parents qualify to claim the student as a dependent on the parent's tax return . Period, End of Story. But one thing I want to point out here. The parents *QUALIFY* to claim the student. The parents are *NOT* required to claim the student as a dependent. But even if they don’t, since they *qualify* to claim the student, then if the student will be filing their own tax return the student is *REQUIRED* to select the option for “I can be claimed on someone else’s return”.

Who reports all the education expenses and claims all the credits?

If (and only if) the parents qualify to claim the student as a dependent, *and* the parents actually are claiming the student as a dependent, then:

The parents will claim all scholarships, grants, tuition payments, and the student's 1098-T on the parent's tax return and:

The parents will claim all educational tax credits that qualify.

If the student will be filing a tax return and:

The parents qualify to claim the student as a dependent, then:

The student must select the option for "I can be claimed on someone else's return", on the student's tax return. The student must select this option even f the parent's qualify to claim the student as a dependent, and the parents do not claim them.

Here’s when the parents will claim the student as a dependent, but the parents will NOT claim any of the education expenses or report the 1098-T on the parent’s tax return.

.If the amount of scholarships/grants/529 funds exceeds the amount of qualified education expenses, then the student will report the education stuff on the student’s tax return. The parent will know this when reporting the education on their tax return, because the parent will not qualify for any of the tax credits. (They only qualify for tax credits based on out-of-pocket qualified expenses not covered by scholarships/grants.)  Also, the parent’s will not qualify for the credits depending on their MAGI which is different for each credit, and depends on the marital status of the parent or parents.

In the case where scholarships/grants covers “all” qualified education expenses, the parent’s don’t need to report educational information on their dependent student at all – but they still claim the student as a dependent if they “qualify” to claim the student.

 If the scholarships/grants exceed the qualified education expenses, then the student will report the 1098-T and all other educational expenses and scholarships/grants on the student’s tax return. The student will pay taxes on the amount of scholarships/grants that are not used for qualified education expenses. However, if the student’s earned income reported on a W-2, when added to the excess scholarships/grants does NOT exceed $12,000, then the student doesn’t even need to file a tax return, and nothing has to be reported.

If the student has any other taxable income not reported on a W-2, and it exceeds $400, (not including taxable portion of scholarships/grants) then most likely it’s considered self-employment income. That will require a tax return to be filed and the student will have to pay the Self-Employment tax on that income.

Finally, regardless of the student’s W-2 earnings, if any taxes were withheld on those earnings and it was less than $6350, then the student should file a tax return so as to get those withheld taxes refunded.

1099-Q Funds

 First, scholarships & grants are applied to qualified education expenses. The only qualified expenses for scholarships and grants are tuition, books, and lab fees. that's it. If there is any excess, then it's taxable income. It automatically gets transferred as follows depending on what type of 1040 you’re riling.

1040-EZ excess scholarship income is included on line 1. 1040-A excess scholarship is included on line 7. 1040 Excess scholarhip is included on line 7.

Next, 529/Coverdell funds reported on 1099-Q are applied to qualified education expenses. The qualified expenses for 1099-Q funds are tuition, books, lab fees, AND room & board. That's it. If there are any excess 1099-Q funds they are taxable. The amount is transferred as indicated above with one exception. For the 1040 excess ESA/QTP funds get transferred to line 21 with the annotation “SCH” next to it.

Finally, out of pocket money is applied to qualified education expenses. The only qualified expenses for out of pocket money is tuition, books, and lab fees. Room & board is NOT a qualified expense for out of pocket money.

When you have a 1099-Q it is extremely important that you work through the education section of the program in the order it is designed and intended to be used. If you do not, then there is a high probability that you will not be asked for room & board expenses, and you could therefore be TAXED on your 1099-Q funds.

Finally, if "all" qualified expenses are covered by scholarships, grants, 1099-Q funds and there is ANY of those funds left over, the left over excess is taxable. While the parent can still claim the student as a dependent, it is the student who will report all the education stuff on the student's tax return. That's because the STUDENT pays the taxes on any excess scholarships, grants and 1099-Q funds.

[dyons]

Hello Carl:

Thanks very much for your detailed and thoughtful response. I purchased the download/desktop version of TT; so I can take advantage of multiple filings. Your explanations of the pitfalls of the online version will nevertheless be helpful to other users who read it.

I have also gone carefully through your write up on the determination of who claims the education credits, and have one immediate question. It arises from the fact that you use the expression "scholarship/grants" in the education chart/figure and many times in your textual descriptions.

However, I notice that in only one place in your written description, you add a 529 plan to those items, "scholarship/grants/529 funds". This seems to suggest that 529 funds are different from grants (and of course scholarships), but nevertheles in the same category. However, this is the only use of the words "529 funds" in your written description.

As 529 plans are not used in the pictorial chart, I was led to the left hand side of the figure and ended up with the box that says "Parents claim all ...". Whereas, if the previous decision box ("Scholarships and grants do not cover...") had also included the words "529 funds", I would end up with the box on the right hand side "Student claims all scholarships,...".In other words, the opposite conclusion.

This is a significant difference because, in my situation, I inadvertently paid all expenses (qualified per 529 rules but not all per AOTC rules) with 529 funds. Thus, it would appear that I might end up on the lower right hand box of your chart because the "scholarship/grants/529 funds do not cover all qualified expenses" is now FALSE. However, the text as written without 529 directs me to the opposite conclusion.

So, am I correct in saying that you inadvertently left out 529 from the expression "scholarship/grants" throughout the text and the picture, and we should read that phrase as always including it?

Thanks for any clarification.

Best regards.

[Carl]

I can't help but giggle a bit here. I was concerned my response would be so long and drawn out (and it is) to the point of either total confusion, or total boredom. hehehehehe.

So, am I correct in saying that you inadvertently left out 529 from the expression "scholarship/grants" throughout the text and the picture, and we should read that phrase as always including it?

For the most part, you are correct. But there is a definable difference between scholarships/grants and 529 funds.

Scholarships and grants can only be used to pay for the qualified education expenses of tuition, books, and lab fees. That's it, with no exceptions. But the category of "lab fees" is rather broad and can include things like the purchase of a computer, if having a computer is a requirement for the students education. But there are limits that I can cover upon your request if you deem it necessary.

529 funds can be used for the qualified education expenses of tuition, books and lab fees, and the unqualified but allowed expenses of room and board, provided that room and board paid for with 529 funds was in direct support of the education. A lot of folks miss out on the 529 stuff because they don't think about what "room and board" includes, and more importantly what it *does not* include.

The ROOM part is more than just rent. It also includes the cost of utilities like water, gas, electric, and even internet access if that internet access is needed for the education. (Most college professors require that papers be submitted on line, so that makes internet access absolutely necessary for the student.)

The BOARD part is the cost of food. If the student lives on campus then more than likely you're paying for a "food plan" for each semester. If paid with 529 funds, then those funds are used to pay it, tax free.  If they live off campus in a place their renting, its a good idea to keep all grocery receipts, but it's really not necessary or required *provided* what you include for food costs is "reasonable". In other words, don't go feeding your student steak and lobster three times a day. That won't fly with the IRS, as no college student in their right mind spends $60 a day on food. Be reasonable, taking into account the cost of living in the student's locale where they live.

Now while there are set maximum rates that one can claim for each meal, that rate differs from one location to the other. For example, when my son attended college at UCF he was living in an off campus apartment and shopping for his own food each week. In Orlando a reasonable cost for each meal back in 2005 was around $6 for breakfast, $8 for lunch, and $11 for dinner.  But in a place like New Haven, Connecticut where Yale University is, breakfast could easily cost $12 to buy the ingredients to make it in a local grocery store.

So the thing is, "be reasonable". If in the IRS's eyes your claim for room and board is to high for the school your student is attending, you'll get a nasty gram from the IRS that basically says "prove it". You don't need that headache.

Some thing that you can not deduct if paid with 529 funds:

If your student signed a one year lease on a rental close to college and that's where they live while attending college, if they remain in the lease and continue to pay the rent for the three months of the summer they are "NOT" attending college, then the room and board for those three months is NOT in direct support of the education, and therefore does not qualify as an expense necessary for the students education. But so long as the student is enrolled in at least one course for the summer semester, you're good.

[dyons]

Hello Carl:

I thank you very much for your detailed responses. While it is VERY useful information, it is not addressing the specific question I have. May I try again, with an example, and see which end point I should arrive at in your figure/flow chart. The difficulty is your asking us to read everything LITERALLY and not "read between the lines". I fear I may have done that when I found one instance when you had included the 529 in "scholarships/grants/529 funds" but nowhere else. Was that a deliberate choice to use it in that one instance? Or did you just forget to include it in the other instances? Thus, a LITERAL interpretation would mean that if you left out 529 funds from various expressions, you were deliberate in your choice and meant it to be exactly as written. Am I correct in this interpretation?

So, instead of discussing each instance of "scholarship/grants" with and without "/529 funds" attached, and especially for the figure/flowchart, could I give you my real life situation and ask a few questions on where I end up in the flowchart?

I have paid my son's tuition, a few fees (none of a personal nature), books, dorm room and meal plan with a 529 plan distribution (me=owner, he=beneficiary). These are all 529 allowed items, as you well know, but not all are included in qualified education expenses for AOTC purposes.

I paid for these by asking the 529 plan  to send a check to the school. I understand that this arrangement ensures that he is the recipient of the 1099-Q. I'm not sure that automatically means that he needs to file taxes on any potentially taxable earnings from the 529 distribution.

He get a tiny scholarship of 5K, and no other grants, while his tuition is about 40K. Except for that scholarship of 5K, I pay for everything else as indicated above.

He also has NO income of any sort, and would not be filing taxes under ordinary circumstances. It is only in conjunction with the possible use of the AOTC (or LLC) that the question of filing a tax return for him arises.

He meets all the criteria you have described for him to be a dependent - enrolled as an UG, enrolled at least half time, provides less than 50% of his support and we (parents) will claim him as a dependent. Thus, in the picture/flowchart we arrive at the box "Scholarship/grants do not cover all qualified education expenses".

Can you tell me, based on the data I've given about his scholarship compared to his tuition, which branch I should take? Note that the inclusion of the "/529" here would make me end up on exactly the opposite branch.

So is this a case where I have to read your diagram's text literally, or has the phrase "/529" been inadvertently been left off?

I apologize for going on and on about this, but I am not sure which path/branch to follow. What is the correct answer in my specific situation?

Thanks a LOT.

[dyons]

Hello Carl:

Sorry to bother you, but if you have a moment, please could you clarify the question I asked in my previous post. In your figure/flowchart, for the very last box "Scholarships and grants DO NOT cover all qualified education expenses", would it be correct to include "529 distributions here as well so that it would be correct to state "Scholarships and grants and 529 distributions DO NOT cover all qualified education expenses"?

As I explained in my previous post, the inclusion or exclusion of this ("529 distribution) gives the opposite results (TRUE becomes FALSE).

This is really bothering me. Thanks VERY MUCH for your help.

[Carl]

That is correct. the amount of scholarships, grants and 529 funds that exceed the qualified expenses are taxable income to the student. Not only does the student pay taxes on the excess, but that taxes on that excess is paid at the parent's tax rate if the parents are in a higher tax bracket. The higher tax rate only applies to excess funds. It does not apply to other income the student may have earned. But here's where it can get tricky.

If all taxable income (key word "taxable") from all sources does not exceed the student's $12K standard deduction, then the student does not have to file a tax return at all and pays taxes on nothing. In such a case where all the student's taxable income is less than $12K, the only reason the student would file a return, is if any taxes were withheld on any of that income, so the student could get the withheld taxes refunded to them.

Do note however that under no circumstances is Medicare and Social Security ever refunded. Only the federal income tax (shown in box 2 of a W-2) would be refunded.

[dyons]

Thanks, Carl, for your answer. If I may clarify one point and check if of my understanding is correct: If the parents have taken 4K of expenses to get the maximum AOTC (assuming all other eligibility criteria for AOTC satisfied by them to be able to claim the credit), then the child/dependent on his/her return has to reduce the QHEE by 4K to ensure that the 4K of qualified expenses on the parents' return is not double counted by the student when calculating his potential excess distribution income. Have I got this right?

Is this part done automatically by TurboTax, or does the parent and student have to be extra careful and do it as a "manual" data entry?

Thanks very much, and best wishes for the New Year.

[Carl]

That's right. Otherwise, it would be double-dipping. Also be aware of what is not qualified for the 529 also (You probably are aware, but this is mostly for others reading this thread.)

• Insurance, sports or club activity fees, and many other types of fees that may be charged to your students but are not required as a condition of enrollment
• Transportation costs
• Repayment of student loans
• Room and board costs in excess of the amount the school includes in its "cost of attendance" figures for federal financial aid purposes. If your student is living off campus, ask the financial aid department for the room and board allowance for students living at home with parents, or living elsewhere off campus, as the case may be. If the student is living in campus-owned dormitories, the amount you can include in QHEE is the amount the school charges for its room and board.

[dyons]

Hello Carl:

Responding to the part of your response dealing with expenses that are NOT eligible as qualified 529 withdrawals, can I include certain fees which are not "sports or club activity fees, and many other types of fees that may be charged to your students but are not required as a condition of enrollment" but appear to be essential for enrollment , such as:

- Community Services

- Student Services

- Health Services

These do not appear to be personal preferences (such as sports or club activity fees), but something equally applicable to all incoming students. I don't know how we could actually refuse to pay these items listed above, and still have the student attend.

Thus, is it OK, in your opinion, to include these as QEE reimbursable from a 529 plan? (I do realize that Pub. 970 does not mention fees of this, or any other type in its list on page 51 (2017 version).

Thanks again. Happy New Year!

[Carl]

Take a look at IRS Publication 970 at https://www.irs.gov/pub/irs-pdf/p970.pdf on page 51 under the heading "Qualified Higher Education Expenses". Note this section applies to 529 funds only, and no other source of funding.  As you can see, the word "essential" and the phrase "equally applicable" does not appear. There are 4 numbered items under that heading that cover what 529 funds can be used for tax free. So what you paid for Community Services and Student Services is either a condition of enrollment, or it is not. I would not know for the school your student attends, if it's a condition of enrollment or not. Weather it's essential or not, just doesn't figure in to this.

But any health services or health care provided and paid for (to include the cost of health insurance) I would expect to be claimable as a medical expense in the health care section of your tax return if he student is your dependent. Of course, until all of your medical expenses exceed 7.5% of your income, and all itemized deductions exceed your standard deduction, itemizing your health care costs won't help a bit on your tax liability.

[dyons]

@Carl, this is a followup to the previous line of questions in this thread about qualified expenses, which you so kindly answered in depth. Please could you have a look at https://ttlc.intuit.com/community/Get-your-taxes-done-using-TurboTax/Can-I-use-my-judgement-in-decid... . I wonder if you have a comment or opinion on the issue I raised in this linked post.

Thanks very much in advance.

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