Q. Who should report 1099-Q (not 1099-T)? It's sent to me, but the beneficiary is my daughter.
A. Do not enter the 1099-Q, from the 529 plan distribution, at all. Not on your return, not on the student's. It is fully covered by room & board. It does not matter that room board were actually paid by scholarship, because it was not paid by TAX FREE scholarship. Technically, you are the "recipient" of the 529 distribution. If it needed to be reported (and it doesn't) it would go on your return.
Q. Do I even claim her as my dependent when the scholarship and her income covered her housing and other living expenses?
A. Yes. Support by scholarship is excluded for the dependent support calculation.
Q. Since I didn't pay any money for her college, do I even need to enter 1098-T on my return?
A. No. The 1098-T (like the 1099-Q) is only an informational document. There is no requirement for it to be reported. That said, see "loop hole" below. You are going to (most likely) want to report it, on both your return and hers. She needs to report it on her return, with adjustments, to enter the scholarship income.
The $2200 distribution was not income , on her return (nor yours). Her income last year was $27,000+$20,000 = $47,000. The $27,000 can be reduced by any book, computer and software expenses. We are going to increase her income by $4000, so you can claim the $2500 tuition credit. It takes $4000 of tuition to get the maximum AOC credit. If you didn’t claim it. In previous years, you should look at filing amended tax returns. The deadline for filing an amended 2021 return is 4-15-25.
Q. I read from some posts that I may be able to "split" the scholarship excess. Is it true? If yes, would this work? Is this a correct way to split it?
A. It’s somewhat true, but that’s not the correct way. On your return, you enter $4000 in box 1 and 0 in box 5. On her return, she enters 0 in box 1 and $31,000 in box 5.
Q. Is it legal to do this?
A. Yes.
Q. Will this help lower the tax that we owe?
A. Yes Your tax will be lowered by $2500 and she will pay $480 -$1000 more on her return, depending on your tax bracket (the kiddie tax will apply).
There is a tax “loop hole” available to claim an education credit, for the parents of students on scholarship. 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 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.
The IRS actually encourages use of this technique. From the form 1040 instructions: “You may be able to increase an education credit if the student chooses to include all or part of a Pell grant or certain other scholarships or fellowships in income. For more information, see Pub. 970, the instructions for Form 1040 and IRS.gov/EdCredit". PUB 970 even has examples of how to do the “loop hole”.
