1098T doesn't have at least half time checked, my child took medical leave, do I need to pay tax on her scholarship

[choosybean]

Hi my child was enrolled in college last year, her health deteriorated around March, and had to take medical leave. She was not able to finish the semester and took medical leave in April. 

The school gave her a scholarship for 36K that covered all her room and board, we didn't have to pay anything and also nothing left over either. 

After entering the 1098T information (36K in scholarship, and box 8 at least half time unchecked) Turbotax Premier is telling me my daughter needs to pay tax for the 36k because she is not at least half time. She got healthier towards the end of the year and has enrolled again in Jan 2021. Do we need to create a tax return for her as Turbtax suggests? 

[hbl3973]

choosybean,

The short answer is Yes, scholarship income not used to pay qualified educational expenses is considered unearned income taxable to the student.  Qualified expenses are detailed in IRS publication 970 (https://www.irs.gov/forms-pubs/about-publication-970) and room and board are not on that list.

Now there is perhaps a bit of good news and a further bit of bad news:

Good news: While you cannot claim the American Opportunity Credit on your 2020 tax return, you or your daughter may be able to claim the stingier Lifetime Learning Credit which is also detailed in Publication 970.  This would only be the case if there were actual qualified expense (Box 1 of the 1098-T plus required books and the like purchased for courses).  Read through chapter 3 of Publication 970 thoroughly to determine if such expenses do qualify for the credit.  It will depend on the details of the scholarship's terms.

Bad news: Unfortunately your daughter also gets an additional kick in the teeth from the scholarship income because it is considered unearned income and any amount above $2,100 is subject to the so-called Kiddie Tax reported on form 8615 (https://www.irs.gov/forms-pubs/about-form-8615).  This income is taxed at the parent's tax rate, not the child's.

[Hal_Al]

Although scholarship is treated as unearned income for purposes of the "kiddie tax" (form 8615), it is treated as earned income for purposes of a dependent's standard deduction calculation. So, only the amount over $12,400 will be taxed. 

[hbl3973]

Good point!  Thanks. Of course any earned income from jobs would push more of the scholarship into the kiddie tax stratosphere.  I've just written to my congressperson to ask if she could introduce legislation to have taxable scholarship and grant income treated uniformly as earned income.  The kiddie tax was designed to keep parents from shifting some of their own income to their children in order to get it taxed at a lower rate.  This has had unintended consequences for education.