Kiddie Tax on Scholarship

[CONKS3]

I’m trying to help my daughter file her taxes for the first time. She has no earned income. She only has an unearned taxable scholarship to claim. She should have just over $1500 worth of scholarship to pay taxes on after all of her non taxable expenses are factored in. Her school does not send out W-2’s for excess scholarship. As TurboTax instructs, we have put all the information into TurboTax via the 1098-T and answered all the questions but it is not calculating any taxes. It just keeps calculating her taxes and refunds as $0. When I select review it says that the 8615 form is not ready for filing yet. Is that the issue keeping it from calculating?

[ColeenD3]

She has to file Form 8615. She has unearned income over the allowed amount. 

For tax year 2021, the Kiddie Tax applies if your child has unearned income (usually from investments) exceeding $2,200.

Form 8615 must be filed for any child who meets all of the following conditions.

1. The child had more than $2,200 of unearned income.
2. The child is required to file a tax return.
3. The child either:

1. 17 or younger at the end of 2021
2. 18 at the end of 2021, but only if their earned income (excluding scholarships in the case of a full-time student) didn’t exceed half of their support costs in 2021.
3. Was a full-time student at least age 19 and under age 24 at the end of 2021 and didn’t have earned income that was more than half of the child's support.
4. (Unearned income and support are defined below.

1. At least one of the child's parents was alive at the end of 2021.
2. The child doesn’t file a joint return for 2021.

For these rules, the term “child” includes a legally adopted child and a stepchild. These rules apply whether or not the child is a dependent. These rules don’t apply if neither of the child’s parents was living at the end of the year

Please see this answer by macuser22.

Unearned income defined.

Unearned income is generally all income other than salaries, wages, and other amounts received as pay for work actually done. It includes taxable interest, dividends (including capital gain distributions), capital gains, unemployment compensation, taxable scholarship and fellowship grants not reported on Form W-2, the taxable part of social security and pension payments, and certain distributions from trusts.

Unearned income includes amounts produced by assets the child obtained with earned income (such as interest on a savings account into which the child deposited wages).

[CONKS3]

I understand that she needs to file this form. What I’m trying to understand is why Turbotax is not calculating any taxes owed after I enter all of the 1098-T information showing the excess scholarship amount. She should owe taxes via the 8615 but it still keeps saying $0 owed. 

[SusanY1]

Can you clarify if $1500 is the only income your daughter has on her tax return?

[CONKS3]

Yes. She had $2776 total in unearned taxable scholarship and then she put in the $1208 she paid for books and materials she had to have for classes leaving $1568 she should be taxed on. She has no earned income. I feel like TurboTax has an error because when we tried removing the $1208 for books which would raise it over the $2200 threshold it still was calculating $0 for taxes owed. Something just isn’t adding up. 

[Hal_Al · Accepted solution]

Taxable scholarships are a "hybrid" income category.  They are unearned income for most purposes, including the "kiddie tax".  But taxable scholarships are treated as earned income for purposes of a student-dependent's standard deduction.  So since her income is less than $12,550, it is wiped out by her standard deduction and there is no tax. TurboTax is doing it correctly. 

Her standard deduction is $1568 + 350 = $1918 and will show on line 12a of form 1040. The standard deduction for a dependent is the greater of $1100 or their earned income + $350 (but not more than $12,550).  For the purpose of that calculation, taxable scholarship is treated as earned income.

[Hal_Al]

More good news. There is another 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.

[CONKS3]

I thought that was only if she had earned income that was at least half of her total income. I don’t see anything about this on the instructions for 8615.

[Hal_Al]

It's not if her earned income  was at least half of her total income, it's if her earned income is more than half her support.  But that's not relevant here.  That has to do with whether she is eligible for the American Opportunity Tuition Credit (AOTC or AOC). 

You never needed form 8615 because her unearned income is less than $2200.   Even if her unearned income is more than $2200, form 8615 is not generated if her taxable income is 0.  And, that's the case when her unearned income is taxable scholarship, up to $12,550.

[CONKS3]

Can you please check the comments below because they seem to contradict what you have said here and I feel like I’m getting conflicting advice?

[Hal_Al]

@CONKS3  said "Can you please check the comments below because they seem to contradict what you have said here and I feel like I’m getting conflicting advice?"

Who is that question directed to?  I see no comments below mine. 

@ColeenD3  ??

[CONKS3]

I’m confused and trying to understand because she said we would definitely need to file a 8615 for our situation and you said I don’t. TurboTax is making us add the form to her return so something isn’t adding up. Everything we read says that she needs it and your post is the only one that says we don’t so I’m asking for a second opinion to confirm. It was directed to the first tax expert that said we would definitely need that form. 

[CONKS3]

I also want to be clear that she is filing as someone who can be claimed as a dependent so she cannot take a standard deduction. 

[Hal_Al]

Yes,  she can take A standard deduction.  It's just not automatically the full $12,550. The standard deduction for a dependent is the greater of $1100 or their earned income + $350 (but not more than $12,550).  For the purpose of that calculation, taxable scholarship is treated as earned income.

[CONKS3]

I want to thank you so much for your help and patience. I finally understand everything you were saying above and it makes sense. I wasn’t understanding how the IRS allows scholarships to be considered like earned income for a standard deduction calculation when everything about the kiddie tax talks about a standard deduction of $1100. Now that I understand it is all calculated correctly. Thank you again!