Is any of my son's college scholarship for tuition and housing taxable (and is it taxable on his 1040 or my 1040 if I claim him as a dependent)?

[Hal_Al · Accepted solution]

If it is taxable, it goes on his return, not yours. Scholarships for room & board are taxable.

 Taxable scholarship, including Pell grants, is the amount of the scholarship that exceeds qualified educational expenses (QEE-tuition, fees and undergraduate course materials). If your dependent had no other income and his grants do not exceed his QEE by more than $6300 (~$12,000 for 2018-20), he does not need to file a tax return.

 There is a tax “loophole” available. The student reports all his scholarship, up to the amount needed to claim the American opportunity credit, as income on his return. That way, the parents 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 2. 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.

[deltadawn1999]

If my son (age 18) receives scholarships and grants and he has a Michigan Educational Trust account, when combined exceed the charges for tuition, qualified expenses and housing, who reports the 1098-T and 1099-Q info?  If I am reading everything correctly, he reports the earnings from the MET as "Other Income"-1040 Line 21, and he reports the housing costs as "Earned Income"-1040 Line 7 (when combined exceed the $6,300 limit); and I report the 1098-T info (that gives me the American Opportunity credit) - Can this be confirmed?  Thank you for your time and assistance.

[Hal_Al]

It’s complicated.
For 529 plans (MET) there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP),  to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q.
The 1099-Q gets reported on the recipient's return.** The recipient's name & SS# will be on the 1099-Q.
Even though the 1099-Q is going on the student's return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because he is your dependent.
You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The educational expenses he claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit,  that gets him an exclusion from the taxability of the earnings (interest) on the QTP. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. Another special rule allows you to claim the tuition credit even though it was "his" money that paid the tuition.
In addition, there is another rule that says the 10% penalty is waived if he was unable to cover the 529 plan withdrawal with educational expenses either because he got scholarships or the expenses were used (by him or the parents) to claim the credits. He'll have to pay tax on the earnings, at his lower tax rate (subject to the “kiddie tax”), but not the penalty.

Total qualified expenses (including room & board) less amounts paid by scholarship less amounts used to claim the Tuition credit equals the amount you can use to claim the earnings exclusion on the 1099-Q.
Example:
  $10,000 in educational expenses(including room & board)
   -$3000 paid by tax free scholarship
   -$4000 used to claim the American Opportunity credit
 =$3000 Can be used against the 1099-Q (usually on the student’s return)

Box 1 of the 1099-Q is $5000
Box 2 is $600
3000/5000=60% of the earnings are tax free
60%x600= $360
You have $240 of taxable income (600-360). It does go on line 21 of form 1040, and  will be labeled as "Qualified state tuition program from 1099-Q"

**Alternatively; you can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip!  When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. It will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.

Any taxable scholarship does go on line 7 of form 1040 (with the notation SCH) and counts toward the student's standard deduction. But it is not technically earned income, for the EIC or an IRA contribution.

[deltadawn1999]

Thank you. That is a lot of information to absorb, after spending the past 2 hours re-doing both his and my taxes, with him reporting both the 1099-Q and 1098-T and still not sure I get it.  I lost my American Opportunity credit.  I keep reading that if the scholarships, etc. exceed the QEE, then the student has to report the 1098-T.  I did it this way, and TurboTax automatically came up with a $$ amount on his where it asked "enter the amount that was used to calculate an education deduction or credit by the person who claimed you as a dependent."  I have no idea where this came from or where I put that number on my taxes.   Thank you again.

[Hal_Al]

Read the original answer above about the "loop hole".  The 1098-T goes on your return, assuming he's your dependent.  The 1099-Q goes on his return.  When you son gets the screen  "enter the amount that was used to calculate an education deduction or credit by the person who claimed you as a dependent.", he enters $4000 because that's the amount that gets you the maximum AOC.

He also has to increase the amount of scholarship he reports as tax able by $4000 (he reports the amount that exceeds the QEE + $4000)

[deltadawn1999]

Awesome.  And I will read it again, but my mind is mush tonight.  Thank you, thank you, thank you.

[Erin03]

Help!  I'm going crazy over the whole 529 and American Opportunity Tax.  I've ready many of your helpful answers but I'm still confused.  

My son has about $3300 of taxable scholarships that were used for room and board.  I used the whole $4000 for the AOC on my return.  I have put the $3300 on his return where it asks if you used scholarship to pay for room and board.  Where do I put the $4000 as income on his return?  I removed his 1099-Q on his return as you had suggested because it was not counting the room and board as a QEE and therefore taxing him for a large portion of the 529 withdrawal.  

Thank you so much for any assistance.  

[Hal_Al]

@Erin03 

Provide the following info for more specific help:

• Box 1 of the 1098-T
• box 5 of the 1098-T
• Box 1 of the 1099-Q
• Box 2 of the 1098-Q
• Was the 1099-Q in your name or his?
• Room & board paid. If he lives off campus, what is school's R&B charge
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers

[Erin03]

@Hal_Al

1098-T:

Box 1:  $11071.12          Box 5:  $14420.

                $ 413.                                        0.

                $ 537.                                        0.

1099-Q:

Box 1:    $23,036        

Box 2:    $14,804

- My son's name on 1099-Q

- $10,400 - School's room & board COA

Other QE:  Books    $656 

                     Internet     $60

Thank you so much!!

[Hal_Al]

First be advised, that a large portion of his 529  distribution IS taxable. You cannot leave off the 1099-Q

I assume the $413 and $537 are additional tuition and fees, so that your total Tuition and fees are $12,021. Is that correct?

  $23,137 in educational expenses (including room & board, books & internet)
   -$8,021 paid by tax free scholarship (student reports (14,420-12,021 + 4000=6399 as income)
   -$4000 used to claim the American Opportunity credit
 = $11,116 Can be used against the 1099-Q (~ 52%  of the $14,804, in box 2, will be taxable)

Does your son have any other income, such as W-2 wages or interest & dividends?

Due to the way a student-dependent's standard deduction is calculated, it is usually better if he reports more taxable scholarship (unless he also has wage income) and less taxable 529 plan distribution. 

Provide the additional info and I'll try to provide more specific instructions. 

[Erin03]

Yes those are additional 1098-T amounts so that total is correct.

My son had a job where he earned $836 with $17 taken out for federal income tax.  He didn't receive a W-2 which i was concerned about but seems like he didn't receive one because it was below a certain amount?

Do I need to track this down?

Turbo Tax asked me what amount of scholarship money had been used to pay room and board.  I put $3348 (14420-11071) at his main school.  

When I had put the 1099-Q into Turbo Tax his taxes were very high.  I knew we would be taxed on the scholarship amount that I withdrew but it seemed really high.  Is that normal?  Would it be better for me not to claim the $4000 AOC than have it on his taxes? My tax rate is low.  I am a widow with only investment income.

I don't understand how I would report "More taxable scholarship and less taxable 529 plan distribution." How do I do that? 

So sorry that I'm confused.  Thank you so much for your help.  And Happy July 4th!!! 

I may not have access to the computer over the weekend but I will get back to you at the beginning of the week!   

[Hal_Al]

Q. My son had a job where he earned $836 with $17 taken out for federal income tax.  He didn't receive a W-2.  Do I need to track this down?

A. Oh, yes. The IRS has instructions on what to do if you receive an incorrect W-2 and the employer is uncooperative: https://www.irs.gov/faqs/irs-procedures/w-2-additional-incorrect-lost-non-receipt-omitted/w-2-additi...

Q.  I put $3348 (14420-11071) at his main school.  

A. That is the usual way.  But there's a better way for your situation. 

Q. When I had put the 1099-Q into Turbo Tax his taxes were very high.   Is that normal? 

A. Yes. What you withdrew duplicated expenses cover by scholarship; some of it will be taxed.

Q. Would it be better for me not to claim the $4000 AOC.

A. No. The AOC is very generous, for some people (probably including you) over 100% credit.  Claim The AOC first.

Q. Should I put the scholarship and/or 1099-Q on my taxes, rather than  on his taxes? My tax rate is low.  

A. No. It's not optional.  Taxable scholarship must go on his return. The 1099-Q must go on his return, because the 1099-Q is in his name.  Next year, you can have the distribution send to you, not to him or the school. But it probably doesn't matter. He's subject to the "kiddie tax", but that just means it's taxed at your rate. not his, and both are low. 

Q. I don't understand how I would report "More taxable scholarship and less taxable 529 plan distribution." How do I do that? 

A.  Very carefully.  I still need to work out the math and will post details later.  TurboTax is capable of handling it, but it's complicated. I'll provide some work arounds.  Your return is simple: at the 1098-T screen enter $4000 in box 1 and leave box 5 blank.  Do not  enter any other numbers. His return will be complicated.

 The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return. You claim the tuition credit, or report scholarship income, based on your own financial records, not the 1098-T. 

[Hal_Al]

Enter only the main school 1098-T, on both your return and his, with modifications. As previously stated, on your return, enter $4000 in box 1 and leave box 5 blank. Enter no other amounts in the TurboTax (TT) interview. That should get you the maximum AOC.

On his return, enter the 1099-Q and complete the 529 distribution interview, before entering the 1098-T. At the 1098-T screen, enter $12,021(11071+413+537) in box 1 and $14,420 in box 5. Enter books ($716) and room & board ($10,400) when asked for books*.  When asked how much of the scholarship was used for room and board, enter $11,014**. Say no when asked if he went to another school (you’ve already included those amounts).

You should reach a screen “education expenses used for a tax credit or deduction”.  Enter the $4000 you claimed on your return.

I calculate $4694 of the 1099-Q as taxable. TT will show this on the student info worksheet and the 1099-Q worksheet and enter the amount on line 8 of Schedule 1

* To get the screen to enter Room & Board, answer yes when asked if you have book expenses.

**This will be the taxable amount of scholarship and is the number needed to get the full $12,200 standard deduction. Even though, room & board may have actually been paid for with 529 money, you have to enter it this way to get the results you need. 

There is a possible additional wrinkle, I had not mentioned earlier. Some of the 529 plan distribution can be subject to the 10% early withdrawal penalty. Having expenses paid by scholarship and/or claiming the AOC offsets this penalty, so I don’t believe it will come up in your case.

[Erin03]

Thank you so much Hal_Al.  I'm going to give this a go and I'll get back to you!  Wow.  So complicated.