1098-T Box 5 is larger than Box 1 and 1099-Q

[rozmz]

Hello,

My daughter received a 1098-T where box 5 ($55,446.57) is larger than box 1 ($27,488.57). I claim her as a dependent because she is 19, a full-time student, and made about $5,400 from her job so she didn't provide more than half of her support.  Do I enter the difference of $27,958 on her return as income? I did some research and found the "loop hole" but I don't know if I'm understanding it correctly. Would I be able to claim $31,958 as income on my daughter's return and then claim $4,000 for the AOC on mine? Lastly, she did receive a 1099-Q so would that go on her return if I claim the AOC? My understanding is that she doesn't have to report the 1099-Q if no credit is claimed. 

[Hal_Al]

Q. Do I enter the difference of $27,958 on her return as income?

A. Yes. You may reduce that amount by any book and computer expenses, or other course materials. 

Q.  Would I be able to claim $31,958 as income on my daughter's return and then claim $4,000 for the AOC on mine?

A. Yes. 

Q. My understanding is that she doesn't have to report the 1099-Q if no credit is claimed. 

A. Not exactly. She does not have to report the 1099-Q if you know that none of it is taxable (the distribution amount is fully covered by expenses).    If shifting some of the tuition expenses to the AOC  means that there are no longer enough expenses for the 1099-Q, then some of the 529 plan earnings will be taxable. But, that's unlikely because you are going to reallocate expenses away from the scholarship instead. You don't need to reallocate any of the 1099-Q expenses.  Room & board are only qualified expenses for the 1099-Q, not the tuition credit or  for the scholarship to be tax free.  

You actually have a situation* where it is better to re-allocate expenses from the 1099-Q to the AOC, rather than from the scholarship to the AOC.  All $4000 of the scholarship income is taxable; while only a percentage of the 1099-Q amount will be. 

Example:
  $11,000 in educational expenses

   -$4000 allocated to tax free scholarship

   -$4000 used to claim the American Opportunity credit

 =$3000 Can be used against the 1099-Q (on the recipient’s return)

Box 1 of the 1099-Q is $5000

Box 2 is $2800

3000/5000=60% of the earnings are tax free; 40% are taxable

40% x 2800= $1120

There is  $1120 of taxable income (on the recipient’s return)

*The amount of taxable scholarship she has is already more than the maximum standard deduction. Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $14,600 filing requirement (2024) and the dependent standard deduction calculation (earned income + $450).  It is not earned income for the kiddie tax and other purposes (e.g. EIC).  

[KrisD15]

The dependent student received 55,447 in scholarships. 

Tuition paid to the school was 27, 489

We don't know about books and supplies

We don't know about Room and Board

We don't know the amount on the 1099-Q

There can be income tax on a 1099-Q distribution and also a penalty tax if a distribution is made and not used for education expenses. Both the account owner and the beneficiary can make distributions. The person that makes the distribution is listed on the 1099-Q and they are liable for the tax (if any).

The penalty tax on a distribution is waved if the student earned a scholarship for as much or more than the distribution. 

The income tax is waived if the distribution was used for education expenses. 

Education expenses that can offset a 1099-Q include the same expenses that an education credit is based on (Tuition, Fees, Books, Supplies) AND expenses that don't qualify for a credit, Room and Board. 

If the distribution is taxed, the tax is calculated on a ratio of earnings to basis (contributions) so there is a bit of a calculation.

Numbers and expenses can be moved around (within reason) to obtain an education credit. 

Yes, you have the option to have the student pay tax on scholarship money in order to "free-up" expenses for the credit, and if there were no 1099-Q, your numbers would be correct, the student could claim 31,958 which gives you 4,000 education expenses to use for the credit. 

Variables include 

What will be the tax bill for the student?

Are you eligible for the credit (your income level) ?

How much was the 1099-Q distribution and what was it used for?

Did the student have expenses not listed on the 1098-T such as books and supplies?

The American Opportunity Tax Credit is only good four times, will the student have more expenses in the next four years (as an undergrad) so you should "save" the credit for those years? 

If the distribution was used for Room and Board and the Room and Board expense was as much or more than the distribution, the distribution won't be a factor and the room and board will also not be a factor. 

This is because only the distribution can go against Room and Board, Room and Board can't go towards a credit. 

If the room and board zeros out the distribution, the distribution is of no consequence and any remaining room and board expense is useless. 

If the distribution was more than room and board, the person that was issued the 1099-Q will need to claim some of that as income OR some education expense will need to be allocated to the distribution. 

IRS Pub 970 has lots of good information. 

[rozmz]

Thanks for the response. I didn't think of ineligibility to claim the credit due to my income. My AGI is about $107,000 as head of household so I wouldn't be able to claim the credit.

The 1099-Q amounts are box 1) $4,635, box 2) $1,802.67, and box 3) $2,832.33. This was all used for rent for my daughter. 

No books were purchased. So, it seems my only option is to have my daughter claim the $27k in income and pay the taxes including the kiddie tax because she qualifies to be claimed on my return since her W2 income of $5,400 was too low to support herself.

[AmyC]

1. The 1099-Q being used for room and board is good. You don't need to report it. IRS Publication 970, Tax Benefits for Education states:

If the entire 1099-Q went to qualified expenses, room and board, tuition, etc then you do not need to enter the form. Tuition paid for the first 3 months of the next year also qualify, see page 12, What Expenses Qualify, and page 52 for qualified distributions.

2. Scholarship income is a hybrid income. It is used as income to determine if she needs to file a return. She does and will claim all of the income on her return where it counts as unearned income and she will file the Kiddie Tax.

3. You will still claim her.