Education Credits and Excess Scholarship Funds

[Lunagizzy]

Daughter is 18 and started her first year of college Fall of 2021 earning her undergraduate degree. I am claiming her as a dependent on my taxes.  She needs to file taxes since she worked a summer job and has earned income that has income taxes taken out.  On the 1098-T form, box 5 ($11,370) is greater than box 1 ($6330.69) for a difference of $5039.31.  She also paid $1900 in books, fees, and equipment out of pocket.  I've seen on the discussion boards about the tax "loophole" where the child reports excess scholarship money (that she got refunded by the school) as "taxable income" but then the parent on their return reports $4,000 in order to get the full $2500 AOTC.  The amount in box 1 from the 1098-T is the amount of tuition for the school but it's also the amount of a school scholarship awarded to her that could only be used to tuition at the school (basically a 1 year full tuition scholarship from the school).  The remaining amount is a private scholarship paid directly to the school but then refunded as money in excess of tuition charges.  I'm not sure how to enter all this into Turbo Tax between my return and her return.  And does she "qualify" to get the full $2500 from the AOTC?

[KrisD15]

Yes, it is true that the student can claim scholarship as income in order for the person claiming the student to claim an education credit. 

Not so much a tax "loophole" as the IRS encourages Taxpayers with education expenses to file in a way that results in the best tax advantage as possible. IRS PUB 970 has some great examples of how to do that. The problem is there are SO MANY ways expenses and payments can be allocated, it can be very confusing. 

IRS PUB 970

If Box 1 (what was paid to the school) in the amount of 6330.69 was covered by a scholarship which HAD TO BE USED for tuition, that expense cannot be used towards an education credit. 

The student can only claim "unrestricted" scholarship amounts. 

It is a bit unclear when you say  "The amount in box 1 from the 1098-T is the amount of tuition for the school but it's also the amount of a school scholarship awarded to her that could only be used to tuition at the school (basically a 1 year full tuition scholarship from the school)." I think this means the amount of tuition and the amount of the scholarship each were 6330.69.

Then I understand that the 5039.31 is the scholarship not used for tuition. 

And there are 1900 additional expenses. 

If I understand your numbers, the student would only have 1900 in expenses (for you to use towards a credit) even if she claims all the excess scholarship. (5039.31)

It COULD be advantageous for the student to claim the income for you to get a credit, but keep in mind:

the American Opportunity Tax Credit (AOTC) is worth the most, (compared to the Lifetime Learning Credit

is "refundable"

Maxes out at 4,000 expenses

and CAN ONLY BE USED 4 TIMES per student. 

If the student might have 5 calendar years of expenses to earn a 4 year degree, you may want to save the AOTC for next year. 

If you can get the same tax advantage with the 1,900 expenses using the Lifetime Learning Credit, don't waste the expenses on the AOTC. 

If the tax the student needs to pay is more than the credit, don't have the student claim the income. 

You can enter the 1098-T and go through the education interview in your TurboTax program. 

The section is lengthy and you need to go through to the end where you will see  "MAXIMIZE MY TAX BREAK".

When you click this, the program will tell you the best way to report the expenses and income to get the best tax break. 

YOUR TurboTax will tell YOU what the student needs to claim as income. 

Scholarship income is reported on line 1 of the student's 1040. 

YOUR TurboTax program does not know things like, what the impact will be on the student's tax liability or how many more years the student will have expenses. 

[Hal_Al · Accepted solution]

Simple answer: You cannot claim the full  $2500 American Opportunity Credit (AOC). You cannot use the full loophole (see description below) because her school scholarship is restricted to being used for tuition ("school scholarship awarded to her that could only be used to tuition at the school").  That is, none of the $6331 in box 1 of the 1098-T can be claimed for the AOC. 

However you can (probably*) count the $1900 in books, fees, and equipment.  The first $2000, of qualified expenses is a  100% credit, so your AOC will be $1900.

*See Q5, Q6, and Q7 at https://www.irs.gov/newsroom/american-opportunity-tax-credit-questions-and-answers

She should already be reporting $3139 as taxable scholarship (11,370 - 6331 -1900 = 3139).  For you to claim the AOC, she should report $5039 (11,370 - 6331 =5039) as taxable.

_______________________________________________________________________________________

You essentially have to use a work around in TurboTax (TT). Here's how I would do it. Enter the 1098-T, on your return, but only enter $1900 in box 1. No other numbers. You only enter the 1098-T to get TurboTax to check the proper box on form 8863. Lying to TurboTax to get it to do what you want does not constitute lying to the IRS. What  you input is not sent to the IRS. 

Enter the 1098-T, exactly as received, on the student's return. Enter book expenses separately.  In his/her interview, you should eventually reach a screen called "Amount used to calculate education deduction or credit" Be sure the amount in that box is $1900 (TT will not automatically populate it with $1900). That will put all his excess scholarship as income on his return.  

Be advised some people are saying they're not getting the "Amount used to claim the tuition deduction or credit" screen on the dependent’s . The alternate workaround is  to enter $1900 less than the actual box 1  amount, when you enter the 1098-T

There's yet another (and simplest) work around. Manually calculate the taxable amount of scholarship ($5039) and enter the 1098-T, on his return, with 0 in box 1 and the  taxable amount ($5039)  in box 5. In that case be sure the amount in the  "Amount used to claim the tuition deduction or credit", if it show up,  box is 0.

____________________________________________________________________________________

There is a tax “loop hole” available. The student reports all his scholarship, up to the amount needed to claim the American Opportunity Credit (AOC), as income on his return. That way, the parents  (or himself, if he is not a dependent) can claim the tuition credit on their return. They can do this because that much tuition was no longer paid by "tax free" scholarship.  You cannot do this if the school’s billing statement specifically shows the scholarships being applied to tuition or if the conditions of the grant are that it be used to pay for qualified expenses.

Using an example: Student has $10,000 in box 5 of the 1098-T and $8000 in box 1. At first glance he/she has $2000 of taxable income and nobody can claim the American opportunity credit. But if she reports $6000 as income on her return, the parents can claim $4000 of qualified expenses on their return.

Books and computers are also qualifying expenses for the AOC. So, extending the example, the student had another $1000 in expenses for those course materials, paid out of pocket, she would only need to report $5000 of taxable scholarship income, instead of $6000.

[sonofdod]

My daughter's scholarships are not restricted to tuition.

[sonofdod]

Sorry, wrong thread.

[Hal_Al · Accepted solution]

If your daughter's scholarships are not restricted to tuition, you change the $1900 to $4000.

She should already be reporting $3139 as taxable scholarship (11,370 - 6331 -1900 = 3139).  For you to claim the full ($2500)  AOC based on $4000 of expenses, she should report $7139 (11,370 - 6331 - 1900 + 4000) as taxable scholarship.  Another way to say that: $4000 of her $6331 tuition is now used for the AOC, leaving $2331 of tuition allocated to scholarship. Her $1900 of books is also allocated to scholarship.  11,370 - 2331 -1900 = $7139 taxable scholarship.

_______________________________________________________________________________________

You essentially have to use a work around in TurboTax (TT). Here's how I would do it. Enter the 1098-T, on your return, but only enter $4000 in box 1. No other numbers. 

Enter the 1098-T, exactly as received, on the student's return. Enter book expenses separately.  In her interview, you should eventually reach a screen called "Amount used to calculate education deduction or credit".  Be sure the amount in that box is $4000 . That will put all her excess scholarship as income on her return.  

Be advised some people are saying they're not getting the "Amount used to claim the tuition deduction or credit" screen on the dependent’s . The alternate workaround is  to enter $4000 less than the actual box 1  amount, when you enter the 1098-T

There's yet another (and simplest) work around. Manually calculate the taxable amount of scholarship ($7139) and enter the 1098-T, on his return, with 0 in box 1 and the  taxable amount ($7139)  in box 5. In that case be sure the amount in the  "Amount used to claim the tuition deduction or credit", if it show up,  box is 0.

[Hal_Al · Accepted solution]

@Lunagizzy  said:

I have a 2nd child also in college (she qualifies as my dependent and I will claim her).  Box 1 of the T-1098 is $6120 and box 5 is $3710 with another $100 for books.  If I enter the numbers as is on the T-1098 on my tax return, then I only get $2100 back. She has to file since she had a job last year but made less than $7000 in income for the year. 

Q.  What portion of her scholarship ($3710) should I put as taxable income on her return?

A.  $1600.  This, of course, assumes her scholarship is not restricted. The fist $2000 of expenses is credited 100%  but the American Opportunity Credit (AOC). The 2nd $2000 is only 25%.  So, to get another $400 of  credit, the student will have to declare $1600 of he scholarship as taxable, to free up $1600 of expenses for the AOC.   $1600 added to $7000  is still  not enough for her to incur a tax liability. 

Q. How do I adjust the numbers to take advantage of the full $2500 credit?

A.  The same as before.  Adjusting the previous answer for your 2nd student's numbers:

Enter the 1098-T, exactly as received, on the student's return. Enter book expenses separately.  In her interview, you should eventually reach a screen called "Amount used to calculate education deduction or credit".  Be sure the amount in that box is $4000 . That will put all her excess scholarship as income on her return.  

Be advised some people are saying they're not getting the "Amount used to claim the tuition deduction or credit" screen on the dependent’s . The alternate workaround is  to enter $4000 less than the actual box 1  amount, when you enter the 1098-T

There's yet another (and simplest) work around. Manually calculate the taxable amount of scholarship ($1600) and enter the 1098-T, on his return, with 0 in box 1 and the  taxable amount ($1600)  in box 5. In that case be sure the amount in the  "Amount used to claim the tuition deduction or credit" box (if it even shows up) is 0.