Scholarship exceeds tuition: How to allocate it best? Can either of us take education credit?

[Working_on_it]

Hello, I am the parent of a college student whose 1098-T shows more grant money than tuition; however, this is a need-based grant that was also awarded to meet full financial need (including room and board). 

The grant money exceeds the stated billed amount by about $3k. We also had 529 distributions (used for educational expenses). 

We claim my daughter as a dependent. TurboTax walked me through some scenarios where I could allocate that our (parent) out-of-pocket expenses went to tuition, and the school grant partially paid room and board (not untrue) to qualify for the AOTC.

The problem arises when I input the 1098 info in my student’s taxes (TurboTax asks for this). She only made $700 from a summer job W2. Grant money was $3k above tuition. TurboTax is taking all 529 distributions and taxing it, plus taxing the 1098-T numbers on my daughter’s return. (Saying she owes over $2,000 in federal tax). 

This can’t be. At best, she made $3700 (grant excess plus job). Moreover, I think we may already have paid unnecessary taxes on these 529 distributions. Since when are they taxable income? Any help would be appreciated! 

[Hal_Al]

@Working_on_it 

 $700 from a summer job W2 and $3K grant money is not enough for her to file a tax return.  She can just not file. 

The TT interview is complicated. What you're experiencing is not unusual.  

If you want to continue, Provide the following info and I'll verify your conclusion  and try to give you step by step instructions:

• Box 1 of the 1098-T
• box 5 of the 1098-T
• Any other scholarships not shown in box 5
• Does box 5 include any of the 529/ESA plan payments (it should not)
• Is any of the Scholarship restricted; i.e. it must be used for tuition
• Box 1 of the 1099-Q
• Box 2 of the 1099-Q
• Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)?
• Room & board paid. If student 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
• Is the student an undergrad or grad student?

[Working_on_it]

Thank you so much for your valuable assistance! I don’t want to mess this up and affect her financial aid award for next year.

• Box 1 of the 1098-T: $29,978.50
• box 5 of the 1098-T: $32,695.00
• Any other scholarships not shown in box 5: N/A
• Does box 5 include any of the 529/ESA plan payments (it should not): No
• Is any of the Scholarship restricted; i.e. it must be used for tuition: No
• Box 1 of the 1099-Q: $7,662
• Box 2 of the 1099-Q: $1,961.38
• Who’s name and SS# are on the 1099-Q, parent or student (who’s the “recipient”)?: student
• Room & board paid. If student lives off campus, what is school's R&B charge. : We were charged $9,662 for room/board. The grant is given to cover the full cost of attendance *after* the family’s ability to pay is considered. So for tuition plus room/board (the school does not differentiate or restrict), we paid out of pocket roughly $6500 in 2021. This was for actual billed expenses (tuition/on-campus room/board).
• Other qualified expenses not included in box 1 of the 1098-T, e.g. books & computers: $1500
• Is the student an undergrad or grad student?: Full-time undergrad. 
  
  Thank you again, sincerely.

[AmyC]

So the 1099-Q does not even cover room and board. Tuck it away and don't bother to file it. This leaves $2k of room and board to be covered by scholarship in box 5. This brings box 5 down to $30,695 minus tuition yields $717 excess income. I would bet you had books and supplies of that much. That zeroes you out.

You want to go for the AOC though. The maximum needed out of pocket is $4k for full credit. Let's go a different direction. Expenses are box 1 + room and board = $39,640. Minus $4k needed for credit = $35,640 expenses left to cover.

Expenses -529 - scholarships = $4,717 excess scholarship income to the student. Again, 529 fully used and does not need to be entered.

The parent claims the $4k and AOTC.  The phaseout for  AOTC is:

$80,000-$90,000 or

$160,000- $180,000 MFJ

Reference:  2021 Publication 970 - Internal Revenue Service 

@Working_on_it

[Working_on_it]

Thank you SO MUCH. This has been a lifesaver. Just to confirm, does this also mean my daughter does not need to bother filing a return since the info is all adjusted for in the parent (my) returns?

[Hal_Al]

You can ignore the 1099-Q.  Box 1 is fully covered by Room & Board. The 1099-Q does not need to be entered and shouldn't be entered. As you know,  it just makes the calculations more difficult. 

On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 

As you surmised, you can claim the AOTC on your return.  The simplest way is to enter the 1098-T with $4000 in box 1 and 0 in box 5.  Lying to TurboTax to get it to do what you want does not constitute lying to the IRS.  What you enter is not sent to the IRS; it's just used for calculations. 

$29,979 Tuition & Fess

+  1,500  Books & computers

-     4,000  Used by the parent for AOTC

=$27,479 Qualified expenses for the Scholarship

 $32,695  Total Scholarship

-  27,479    Qual. Expenses

=   5,216     of the Scholarship is taxable

Technically, she does not even have to file a tax return ($700 + 5216 = 5916 < $12,550 filing requirement).  You may want to have her file just to document that the taxable scholarship was reported (freeing up $4000 tuition for the AOTC).   The simple way is to enter the 1098-T with 0 in box 1 and $5216 in box 5. 

[Working_on_it]

Thank you! If I have my daughter file, do we just enter that excess scholarship income on a line somewhere (e.g. other untaxed income)?

edit: just saw that you explained it in your last sentence. Thank you!!

[Hal_Al]

Yes. If you are preparing form 1040 by hand, do this:  Enter $5916 on line 1 (the $700 W-2 + the $5216 taxable scholarship).  On the line to the left of line 1, enter SCH 5216. 

If you're using TurboTax (TT), TT will do that for you, but you must enter the scholarship income in the 1098-T/education expenses section, not the income section.  The simple way is to enter the 1098-T with 0 in box 1 and $5216 in box 5.