Q. Basically, THE STUDENT simply adds $4000 to whatever the taxable portion of scholarship would be, ON HIS RETURN, and pays the unearned income tax ramifications of that extra $4000 on dependent’s return so I can take the AOTC on my return.
A. Yes
Q. I had been interpreting the T-1098 as document to transcribe literally, box for box?
A. No. The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return. You claim the tuition credit, and report scholarship income, based on your own financial records, not the 1098-T. The 1098-T that you enter in TT is not sent to the IRS.
Q. Yet I’m still struggling to fathom the “why” the workaround works. Is it that I’m essentially volunteering to pay more tax on my son’s return in order to claim that AOTC on my return?
A. Yes. You are re-allocating the tuition from the scholarship to the credit. You're allowed to do that.
Q. If so, I’m still not clear how / why it’s legit for tax purposes to claim the AOTC when I did not actually pay the university $4000 of qualified expenses, since most were covered by his scholarship?
A. Before the reallocation, the tuition was being paid by tax free scholarship. After the reallocation, it's being paid by your son's taxable income, so you can put it on your return because the family has effectively paid the tuition.
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”.
Q. If my son also has approx. $8000 of earned income (W-2 or NEC). Does additional earned income impact the workaround?
A. No, but $8000 more of the scholarship will be subject to the kiddie tax. The wage income is covered by the standard deduction, rather than the scholarship.
I trust your guidance. I’ve read many of your posts and am convinced you are the guru of this topic! Yet I have to understand the “why” in order to feel ok using the workaround and claiming the credit.
2) If my son also has approx. $8000 of earned income (W-2 or NEC),
Does additional earned income impact the workaround?
