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Are you also getting an education credit?
If you select "Maximize My Tax Break" after entering the 1098-T, the program may tax part of the scholarship and give you a credit if the increase in credit is more than the tax.
You are able to go back through the Education Interview and select a different option.
Example: you have $10, 000 in box 5 of the 1098-T and $11,000 in box 1. You only have $1000 of net qualified educational expenses (QEE) to claim the tuition credit on your tax return. You need $4000 of QEE to claim the maximum $2500 American Opportunity Credit. So, TurboTax is telling you to have the student declare $3000 of his scholarship as taxable, to allow you to claim the maximum credit.
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”.
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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.
Thank you for your answer. However the amount of tuition is $32k and the scholarship is $7 so I don't think this applies.
Q. However the amount of tuition is $32k and the scholarship is $7 so I don't think this applies?
A. You are correct. None of the $7K is taxable. You've entered something wrong. In particular, be sure you did not say that some of the scholarship was used for room & board (r&b are not qualified expenses for a scholarship to be tax free).
Otherwise, delete the student and start over. Go through the entire education interview until you reach a screen titled "Your Education Expenses Summary". Click delete next to the student's name. You'll then get the "Your Education Expenses Summary" screen again. Click the "Add a student" button.
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