Education Credit

[user17762160804]

I claimed my dependent child with scholarship and form 1098-T for education credit. I used $4000 on my 1040 as qualifying education expenses. Now I am trying to file their taxes. Their 1098-T Box 1 has $12,800 and Box 5 has $12,000, with Box 7 and Box 8 checked. How to minimize their tax liability and avoid kiddie tax?

[Hal_Al]

Q. How to minimize their tax liability and avoid kiddie tax?

A. There is little you can do other than reduce or forego the tuition credit you claim on your return. In addition to tuition and fees, you can count books, a required computer and other course materials as qualified expenses for tax free scholarship. 

For most students, the taxable amount of scholarship is so small that no tax (and no kiddie tax) is actually due, depending on what other income she has.  The $3200* of taxable scholarship she currently has is not enough to even have to file a tax return. Although you may want to have her file to document the reporting of the income, for the purpose of you claiming the AOTC. 

*12,000 - (12,800 -4000) =$3200 taxable scholarship

Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $15,750 filing requirement (2025) and the dependent standard deduction calculation (earned income + $450).  It is not earned income for the kiddie tax and other purposes (e.g. EIC).  For grad students and post grad fellows, scholarship, stipend and fellowship income is earned income ("compensation") for IRA contributions.

Taxable scholarship goes on line 8r of Schedule 1, from which TT treats it as hybrid income.

[user17762160804]

Thanks for the quick response.

"A. There is little you can do other than reduce or forego the tuition credit you claim on your return." I have already filed my returns. My question was about best option for filing my dependent's return. So if my understanding is correct and assuming that there are no other qualifying expenses the dependent would have 3200-2700 = 500 liable for kiddie tax. Is that correct? Thanks.

[Hal_Al]

Q.  So if my understanding is correct and assuming that there are no other qualifying expenses the dependent would have 3200-2700 = 500 liable for kiddie tax. Is that correct?

A. Technically yes, but effectively no. 

Your calculation is correct. $500 would be subject to the kiddie tax.  But because the scholarship income is "earned income", for purposes of the standard deduction, he gets a 3200 + 450 = $3650 standard deduction which wipes out the whole $3200. Nothing gets taxed.  If he files, he will have to include form 8615 (TT does that automatically. You'll see the no tax calculation in Part I). This assumes, he has no other income, particularly, other unearned income.