Q. How can this amount be added to the "Wages, salaries, tips" line of the tax return without a W-2? Or should it be reported as "Other Income"?
A. It does not go in either of those places. It MUST go on line 8r of Schedule 1*. It gets there by entering it, as described above, in the educational expenses (1098-T) section of TurboTax (TT). Do not enter it in the income section.
Q. In our case Grants exceeds tuition and even after deduction required education expenses, there is still remaining balance and it is considered taxable income and must be reported. So, the American Opportunity Credit (AOTC) does not apply, right?
A. No. Or more accurately probably not.
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 $4,000 in box 5 of the 1098-T and $3000 in box 1. At first glance he/she has $1000 of taxable income and nobody can claim the American opportunity credit. But if she reports $4000 as income on her return, the parents can claim $3000 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. The parents can now claim $4000 for the AOC.
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”.
*Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $14,600 filing requirement (2024) 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.
