When scholarships are greater than tuition, you can usually still get a credit, but you have to report it just right. (Also, the “phaseout” of the American Opportunity Credit starts at $160,000 of AGI, so only a partial credit is available over that.)
The main concept is that any dollar of “qualifying expenses” (i.e. tuition and fees) can be used for only one tax benefit: to exclude a dollar of the scholarship from taxation or to get a credit (but never both—that’s called “double-dipping,” and can lead to headaches).
The good news is you’re actually allowed to allocate as much as you want of the scholarship to something else besides tuition (like “room & board,” which you’ll see in the TurboTax screens), increasing the tax on that (on the student’s return, if they’re required to file), so you have more tuition to use for the AOC, which is actually larger than that additional tax (sometimes much larger).
Here is the IRS telling us about this treatment, to make you more comfortable with it. With a scholarship that’s paid directly to the school, some people worry that it’s cheating if they treat it like they paid that tuition, but it’s not, as long as the scholarship was not specifically earmarked for tuition. Also, here’s another Community discussion, with some TurboTax specifics.
@jul31, I hope this was clear. It can get tricky, so if you’re unsure about anything as you make the entries, be sure to come back here with questions! The IRS likes to check on education stuff, but hopefully the Community can help you feel confident about this.
When scholarships are greater than tuition, you can usually still get a credit, but you have to report it just right. (Also, the “phaseout” of the American Opportunity Credit starts at $160,000 of AGI, so only a partial credit is available over that.)
The main concept is that any dollar of “qualifying expenses” (i.e. tuition and fees) can be used for only one tax benefit: to exclude a dollar of the scholarship from taxation or to get a credit (but never both—that’s called “double-dipping,” and can lead to headaches).
The good news is you’re actually allowed to allocate as much as you want of the scholarship to something else besides tuition (like “room & board,” which you’ll see in the TurboTax screens), increasing the tax on that (on the student’s return, if they’re required to file), so you have more tuition to use for the AOC, which is actually larger than that additional tax (sometimes much larger).
Here is the IRS telling us about this treatment, to make you more comfortable with it. With a scholarship that’s paid directly to the school, some people worry that it’s cheating if they treat it like they paid that tuition, but it’s not, as long as the scholarship was not specifically earmarked for tuition. Also, here’s another Community discussion, with some TurboTax specifics.
@jul31, I hope this was clear. It can get tricky, so if you’re unsure about anything as you make the entries, be sure to come back here with questions! The IRS likes to check on education stuff, but hopefully the Community can help you feel confident about this.
What's missing from your post is: how much is shown in box 1 of the 1098-T. TurboTax will only use the difference between box 1 and box 5 (assuming box 1 is the larger amount) to calculate your tuition credit, until you do some allocating of expenses. Basically, you may need to allocate some of his scholarship to Room and board to free up tuition for you to claim the credit (AOC)*.
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.
*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.