Q1. Where is the scholarship portion of the unearned income entered in TT (or is it automatically determined from the difference of (Box 5 - Box 1) on 1098T?
A1. Automatically determined from the difference of (Box 5 - Box 1) on 1098T, but reduced for any additional qualified expenses and/or increased for the amount of tuition used by the parent to claim the American Opportunity [tuition] Credit (AOTC). The TurboTax interview can handle this, but it can get tricky. Reply back if you need a short cut. Room & board are not qualified expenses.
Q2. The "extra" scholarship amount is > $2500 - hence a separate tax return is required. However, this unearned income is less than $13,850 (standard 2023 deduction, single) - does this mean there is no tax owed, because the AGI is less than $13,850?
A 2. If that is his only income, and the taxable amount is less than $13,850, it does not get taxed. He does not even need to file a tax return*.
Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $13,850 filing requirement and the dependent standard deduction calculation (earned income + $400). It is not earned income for the kiddie tax and other purposes (e.g. EIC). For grad students and post grad fellows (but not undergrads), scholarship, stipend and fellowship income is earned income ("compensation") for IRA contributions.
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Q 3. Does he need to fill Form 8615, and provide parents AGI and tax related info? Is there any kiddie tax owed?
A 3. Form 8615 is not required unless his total earned income, including the taxable amount of the scholarship exceeds $13, 850 by more than $1250. No kiddie tax will be owed unless the excess amount is $2500 or more.
Another thing to be aware of: There is a 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 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.
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”.
* If you claim the tuition credit, under the "loop hole", you may want the student to file a tax return, even if not required, just to document the reporting of the scholarship as income.
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