Scholarship/grant refunds paid in January for the prior Fall term

[bhappy]

Scholarships/grants exceeded IRS qualified expenses in my dependent son's first term (Fall 2022). Since he did not pay tuition a 1098T was not provided. We are aware he must report the non-qualified portion as income and will not qualify for AOTC. He has no other earnings. In September 2022, financial aid was distributed and we paid his room/board balance. In December 2022 we also paid a portion of his Spring 2023 billed balance.

In late January 2023, his school's financial aid office reported additional aid (a CA Middle Class Scholarship and an award error in a University Grant supplemental computation) for the previous Fall 2022 and upcoming Spring 2023 terms. They issued a financial aid refund for his Fall 2022 term since all charges had already been paid.

Since this returned money was scholarship/grant, it offsets balances we paid and increases his non-qualified portion of "income". But, in which tax year should this new "income" be reported (paid to my son in 2023 and earmarked for Fall 2022)?

IRS Pub 970 discusses 1098T and AOTC rules with statements like "deemed to have been paid" or three-month rules regarding paying expenses. Typically earned income is reported in the year it is received while expenses are reported in the year paid (cash basis). Are scholarship/grant rules any different since they are "deemed" to apply to certain terms? We don't want to under report for 2022 if this is not the case.

[AmyC · Accepted solution]

The 2022 refund paid in 2023, should end up in box 6 of the 1098-T for 2023 which would mean the scholarship amount is added to the 2022 tax return. That normally means amending the prior year tax return but since you have not completed in, you can just add it now instead. You can go ahead and add the amount to your scholarships received in 2022.

If your son is a dependent, you may qualify for AOTC. You can say the awards went towards room and board while $4,000 was paid by you and went towards tuition for fall 2022 and spring 2023. The IRS allows the juggling of who paid what provided the scholarship does not have a stipulation that it must be applied to tuition.

If the scholarship income is the only income and it is below filing requirements then no return would be necessary.

The first three months of tuition paid can count in either year depending on how items fall. It is part of the wiggle room.

The scholarship income is the scholarship income for the year. You move the tuition and expenses section, not the scholarship income.

Reference: Pub 970 

[bhappy]

> The 2022 refund paid in 2023, should end up in box 6 of the 1098-T for 2023 which would mean the scholarship amount is added to the 2022 tax return. That normally means amending the prior year tax return but since you have not completed in, you can just add it now instead. You can go ahead and add the amount to your scholarships received in 2022. <

We did not receive a 1098-T this year for 2022 so were unaware of box 6. Thank you for guiding us to it! We will expect next years 1098-T (for 2023) to show this 2022 refund payed in 2023 for 2022 and account for it now as part of his 2022 "income". You are correct that he may not meet the income requirement to file 2022 anyway. We will move forward with the understanding that scholarships/grants, even if paid late, stay with the term/year they apply.

[Hal_Al]

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 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.

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”.