Q. Is it correct that we claimed him as our dependent on our return and he stated on his return that he is a dependent of someone else?
A. Yes.
Q. According to IRS, a taxpayer needs to provide more than half of living expenses/financial support of a qualifying child in order to claim them as a dependent.
A. No. There are two types of dependents, "Qualifying Children"(QC) and Other ("Qualifying Relative" in IRS parlance even though they don't have to actually be related). There is no income limit for a QC but there is an age limit, student status, a relationship test and residence test. The support test, for a QC, is only that the child didn't provide more than half his own support. The support test for a Qualifying Relative is that the taxpayer provided more than half the relative's support.
Q. My understanding is that taxable scholarships are “unearned income” and as such they do NOT count when determining if your qualifying child can financially support themselves.
A. Not exactly. Scholarships are simply ignored in the support calculation. *
You can completely ignore the 1099-Q. Do not enter it. Room & Board more than covers it.
You can claim the full AOTC on your return. For simplicity, enter the 1098-T with $4000 in box 1 and box 5 blank.
On his return, he enters the 1098-T with 0 in box 1 and $33,000 in box 5 ($29,000 + 4000). He will pay $480-$880 more tax on the additional $4K, depending on YOUR tax bracket (the kiddie tax applies on this much scholarship income). But, you will get the full $2500 AOC (depending on your tax liability).
"We had partial AOTC in the last couple of years since he had smaller scholarships which were not taxable."
If your AOTC was less than $2500, you should look at filing amended returns. Depending on how much taxable scholarship he had, maybe only if less than $2000. The AOC is 100% of the 1st $2000 and 25% of the next $2000. His additional reportable scholarship will actually not get taxed if his total income is less than $14,600.
*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 (but not undergrads), 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.
