Should my dependent college girl file tax return for the $3500 undesignated grant that we used for room? Is this unearned income that above $1300 she must file return?

[Vanessa A]

Yes.  That would be considered unearned income and she would need to file a return since she is still your dependent.  Since it was used for room and board and not for qualified education expenses, it is considered income. 

[Hal_Al]

Q. Should my dependent college girl file tax return for the $3500 undesignated grant that we used for room?

A. No, if that was her only income.  Scholarships that pay for qualified educational expenses (QEE - tuition, fees, books and other course materials) is tax free.  Scholarship amounts that exceed QEE is taxable income, on the student’s tax return. Room & board are not QEE.  So, yes the $3500 is taxable income, but it is not enough to have to file a federal tax return. 

Q.  Is this unearned income that is above $1300, and she must file return?

A. No. 

Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $14,600 filing requirement (not $1300) and the dependent standard deduction calculation (earned income + $450).  It is not earned income for the kiddie tax and other purposes (e.g. EIC).  For grad students and post grad fellows, scholarship, stipend and fellowship income is earned income ("compensation") for IRA contributions.

Taxable scholarship goes on line 8r of Schedule 1, from which TT treats it as hybrid income.

You do not report his/her income on your return. If it has to be reported, at all, it goes on his own return. Your dependent child  must file a tax return for 2024 if he had any of the following:

1. Total income (wages, salaries, taxable scholarship etc.) of more than $14,600 ($13,850 for2023).
2.  Unearned income (interest, dividends, capital gains, unemployment, taxable portion of 529 distribution) of more than $1300 ($1250 for 2023). 
3. Unearned income over $450 and gross income of more than $1300.
4.  Household employee income (e.g. baby sitting, lawn mowing) over $2600 ($14,600 if under age 18)
5.  Other self employment income over $432, including money on a form 1099-NEC

Unearned income includes taxable interest, dividends, capital gain distributions, taxable social security benefits, pensions and annuities and Unemployment compensation. Earned income includes wages, tips, and taxable scholarships/fellowships/stipends.

[Hal_Al]

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.

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”.