American opportunity tax credit. Is my son required to reduce the net tuition cost by MN State military tuition reimbursement?

[dodgervb]

I found the following instructions in Pub 970 Tax Benefits for Education.

Veterans' Benefits Payments you receive for education, training, or subsistence under any law administered by the Department of Veterans Affairs (VA) are tax free. Don't include these payments as income on your federal tax return. If you qualify for one or more of the education tax benefits discussed in chapters 2 through 12, you may have to reduce the amount of education expenses qualifying for a specific tax benefit by part or all of your VA payments. This applies only to the part of your VA payments that is required to be used for education expenses. 

My son is in the MN Air National Guard. He receives GI Bill benefits, but these funds are not required to be used for education expenses.  This benefit is deposited directly to his bank account each month. Therefore, based on what I have read, I don't think this is required to reduce the amount of education expense tax benefit.   

My son also applied for the Minnesota State Tuition Reimbursement (STR) benefit for National Guard members.  This requires he submit a invoice from his college showing the amount of tuition charged along with other charges and grants. The STR is then evaluated and approved based on grades and eligible expenses.  This benefit will also deposited directly to his bank account, not to the College. Therefore, my question is, do we need to reduce the amount of education expense tax benefit for this MN STR benefit?

Thanks! 

[DanielV01 · Accepted solution]

Yes tuition expenses should be reduced by the STR, in harmony with what you read in Publication 970.  Note the wording that the reduction occurs for the part of the VA payments required to be used for education expenses.  His Minnesota STR does require him to use these funds toward education.  You will want to be certain that the GI Bill does not require him to use the funds (or a portion of the funds) for education.  If a portion of the GI Bill is required to be used towards education, then you must reduce net tuition amounts not reduced by the STR further by any portion of the GI Bill required to be used for education expenses.  

Having said this, if either you or he is looking to claim American Opportunity Credit, then a way to do so (even if there seems to be no claimable amount for the credit because tuition has been reduced to $0 for being paid with nontaxable funds) is to claim an amount of tax-free payments as taxable scholarships on your son's return.  As long as tuition is paid for by up to $4000 of taxable funds, either you (if you are claiming him as a dependent) or he (if he is claiming himself) can then claim the full amount of credit available for the American Opportunity Credit.

[dodgervb]

Thanks for your reply.  I was thinking that since the STR will be paid to my son's bank account (for use as he sees fit) rather than directly to the college that maybe the STR was not required as a reduction to the education tax benefit.

[DanielV01]

Understandable.  By the definition you provide the IRS probably takes a different view.

[dodgervb]

Got it.  I will consider your recommendation of claiming a portion of the scholarships as taxable income for my son.  Thanks.

[DanielV01]

You're welcome.