Incorrect CA state tax calculation for taxable scholarship money

[iamjking]

Last year I used TurboTax to file our tax return and my college-age daughter's return.  My daughter is our dependent, and she had some taxable scholarship funds, because they were used for room & board.  TurboTax treated these funds as unearned income, reporting it on IRS form 8615 and CA state form 3800 (both are tax for certain children with unearned income).

As it turns out, she owed $0 in federal taxes, because the federal standard deduction was higher than the scholarship amount.  However, for CA, TurboTax computed that she owed $189 in taxes (on line 18), which we paid.  This tax amount was based upon her parents' (our) higher tax rate.  Form 3800 also showed (on line 17) that the tax based on the child's (my daughter) filing status was only $20.

After CA FTB processed my daughter's tax return, they sent a refund of $169, stating that we had incorrectly calculated the tax amount on the return.  They also stated that by their calculation, the tax my daughter owed was $20 (which is the amount I mentioned above, based solely on the child's filing status).

So, my question is, who is correct here?  TurboTax, or the CA FTB?  I tend to think that the CA FTB knows what it is doing.  I'm trying to avoid making the same mistake with TurboTax again this year, because the numbers are much higher.

Thanks in advance.

[Hal_Al]

I'm not specifically  familiar with CA tax forms.

But, scholarship income, while technically unearned income, is treated as earned income for purposes of the calculation of a  student-dependent's  federal standard deduction (earned income + $350, but not more than $12,400) and the federal filing requirement.

It appears CA uses the same rule.  I suspect you entered something wrong in the CA interview. 

[iamjking]

Thank you for that information.  TurboTax CA State never asked me anything about the scholarship money that I recall, other than what the parents' taxable income was and how much state tax the parents were paying.

I'm beginning to think my error might be in the way data was entered on the federal form 8615.  From what I see on IRS form 8615 and its instructions, there is no place where it differentiates interest/dividend/capital gains income from taxable scholarship income.  If there is such a place, could you please direct me to the specific lines on from 8615 to review?  Thank you.

[Hal_Al]

You have to enter scholarship income as scholarship income , not other income.

To do so you enter it in the Deductions and credits / Education section, not in the income section. It goes on line 1 of form 1040 with the notation SCH.  As such, form 8615 (if still needed) will pick it up as earned income.  There is no special line for "scholarship".

[iamjking]

Yes, that is what I have. 

On form 1040, line 1, it shows 'SCH' followed by the amount of my daughter's taxable scholarship.  When I click that schedule link in TurboTax, it takes me to the 1040/1040SR Worksheet, line 1, where 'SCH' followed by the scholarship amount appears again.  When I click that schedule link, it takes me to the Wages, Salaries, & Tips Worksheet.  That worksheet shows the scholarship amount on line 13 (Scholarship/fellowship income not on Form W-2).

So, based upon all of this, everything looks correctly entered in TurboTax.

[iamjking]

I think your statement below is key: "As such, form 8615 (if still needed) will pick it up as earned income.

That is not the case." 

TurboTax is treating the taxable scholarship money as *unearned* income, and thus the presence of form 8615.  My daughter has no investment income.  If I override TurboTax, and tell it there is no need for form 8615, then her federal tax remains at $0 and her CA tax drops to $20, which matches what the CA FTB computed as her state tax.

You mentioned "form 8615 (if still needed)..."

Under what circumstances would form 8615 be needed?

Thanks.

[Hal_Al]

Scholarship income  is actually a "hybrid".

For purposes of the filing requirement and calculating a dependent's standard deduction (earned income + $350 but no more than $12,400), scholarship is treated as earned income. But for purposes of the "kiddie tax" it is unearned income.  Thus, a dependent with scholarship income and total income over  $14,600 ($12,400 + $2200) would be subject to form 8615. 

[iamjking]

Thanks for clarifying that, Hal_Al.

However, this still doesn't explain why TurboTax included form IRS form 8615 on my daughter's tax return last year.  Her total income was around $6500, and all of that was the taxable scholarship amount.  The result of form 8615 was $0 taxes owed to the IRS, but the inclusion of that form is what caused the inclusion of CA form 3800 (California's "kiddie tax"), leading to the incorrect state income tax calculation by the program.

It seems like something is broken here, but I don't know what.