Basically, because that's what it is. Income. All monies you receive from any source are income. But the taxability of that income is a different story through. All scholarships, grants and 529 funds are treated as taxable income *initially*. It's taxability is offset by the qualified education expenses those funds are used to pay for. Pay attention to what's bold italicized below.
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 to line 21 of the 1040 with an annotation of "SCH" next
to it.
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 to line 21 of the 1040 with an annotation of "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 that are 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.
