California tax - child's investment income

[sroussak]

My daughter has a college scholarship, a portion of which is taxable as it is used for room and board - let's say around $4,500 (I'm still calculating the exact amount).  She will be shown as a dependent on my return, so there's no AOTC etc on hers.

I've done her Federal return, and it shows no tax due.  I don't recall specifically being asked questions for the Form 8615 election.  But when I go to do the CA return in TT, it shows CA tax due of around $1,500, after asking what the income is on my 540.  I don't understand how the CA tax due can be so high (a total rate of 30%!) or what I should do to have it taxed at my rate (which is not even the highest rate for CA).

Please let me know.  Thanks.

[hbl3973]

sroussak,

There's not enough detail in your query to advise what to do, but let me note that scholarship income is treated as "W-2" income, not unearned investment income.  (It's included on 1040 line 1 with an annotation SCH.)  So, please explain more about your child's investment income  and why she is not filing her own return?

[sroussak]

Thanks for getting back to me, and sorry if I was imprecise.  It is my daughter's return that I'm asking about - I've reported the $4500 in taxable scholarship in answer to the questions for her federal return, and now I'm trying to understand why the CA tax is so high.  There is no other income on her return.

I can't get TT to show me the actual return as it stands, and I didn't realize that the taxable scholarship went on line 1.  I was under the impression that it was treated as unearned.

Thanks

[hbl3973]

sroussak,

My apologies for the delay.  I also volunteer with AARP TaxAide and have been kept busy the last several days with remote assistance while taxpayers prepare their online taxes.

You are certainly correct that your daughter should not have a large CA tax bill if the scholarship is the only sizeable portion of her income.  Indeed, her standard deduction in CA is at least the amount of the scholarship.  Not seeing your return,  I cannot fully diagnose what is going on, but I strongly suspect that the scholarship income isn't being treated as earned income. (You should also inspect all entries for typos, e.g. an entry where you failed to type a decimal point when entering the cents.)  I would go back to the federal return and remove the scholarship entry, wherever it was, and reenter the amount by drilling down into Miscellaneous Income and either entering the scholarship under Other Income Not Reported On a Form W-2 or entering it under Other Reportable Income.  After that proceed to the state section and make sure there is no child's unearned income or at least that the scholarship isn't part of her unearned income.

Finally, should all else fail, go ahead an e-file the federal and download the CA 540 fillable PDF and its instructions.  You'll find that it will be very straightforward to complete and she can sign and mail it at the post office.  (If the scholarship is her only income and is, indeed, no more than $4,537, she doesn't have to file a CA return.)

[hbl3973]

Whoops, I wasn't thinking straight.  The taxable portion of the scholarship, while reported on the federal W-2 line is unearned income, but not investment income.  Therefore it is subject to kiddie tax IRS Form 8615 and CA FTB3800.

As a dependent, her standard deduction in CA is $1,100 so her taxable income is $3,400.   The first $2,200 of that is taxed at her 1% rate and the remaining $1,200 is taxed at your rate which is likely under 10% and absolutely no more than 12.3%.  So the tax should be on the order of $220+$120 = $340.  $1500 certainly makes no sense.

[hbl3973]

Considering the date being 7/15/2020, I suggest she go ahead and mail a CA extension form FTB 3519 with a $350 payment.  That form and how to pay are at

https://www.ftb.ca.gov/file/when-to-file/extension-to-file.html

[sroussak]

Thanks for the advice, I've now been able to get TT to show me the actual returns it wants to file and you're correct: while it shows the $4,500 on Form 1040 line 1 with a "SCH", it's treating it as unearned income, with a form 8615 in the federal return and a 3800 in the CA return.  I assume the 30% CA rate is the TCJA rate, ie it's not letting me elect the pre-TCJA rate (still can't believe a CA rate would be that high but whatever..).

The only place where the income comes up in the questionnaire is in connection with the student scholarship questions, so maybe it's some kind of glitch in TT that treats it as unearned.  What's really odd too is that if I play around with the number I get some weird results:  at $2200 it shows no CA tax due at all, but at $2300 it shows the same $1583 due that it shows at $4500.   I'm no expert but that doesn't sound right!

So I think I should probably take your advice and print a CA540 to complete by hand (the number is technically $4,600 so it is above the threshold you cite).  The only question then is if there's any downside to leaving the 1040 as TT has prepared it, showing the income as unearned, if it still shows no federal tax due.

Thanks again

[sroussak]

Just saw your updated response after posting - thanks, sorry to be taking up your time with this.  Makes sense now, so no glitch in how TT reports the income on the returns, only in how it's calculating the CA tax due.  So I guess I'll leave the 1040 as is and go ahead with a hand-filled 540.

[hbl3973]

The maximum CA tax rate is 12.3% for incomes at least a half a million dollars!

[hbl3973]

Interestingly, the 540 instructions read: "Check the box on line 6 if someone else can claim you or your spouse/RDP as a dependent on their tax return, even if they choose not to."  In your case as I understand it, there is no CA taxpayer who can claim you as a dependent.  Just a thought...

[sroussak]

I thought I saw something about a higher rate for trusts and estates that a child's unearned income was subject to.  But can't imagine it being 30%, even in CA.  And the fact that the amount of tax was the same regardless of the amount of income points to a bigger issue!

RE your last post - she is being claimed as a dependent on my return.

[hbl3973]

FTB 3800 would not invoke estates and trusts.  Just the parent's filing status. Absolute max tax rate 12.3%

[sroussak]

Ok, I believe you. So must have been some odd bug in TT.   Thanks. 

[taxmom50]

Hi, 

I saw your helpful answers on this thread and was hoping maybe you had some idea for me.  My son is a dependent and a Maryland resident. Due to Covid, he spent less than 65 days in California in 2020 but he did earn about $7,000 of income working for his college remotely.  He also had about $5,000 unearned income from a qualified 529 distribution. Turbotax keeps forcing a Form 3800 on him asking for his parents' California tax information. Since we re Maryland residents and don't earn money in California, we don't have a California tax return and can't answer those questions. In addition, he is already paying Maryland taxes on that unearned income, so it seems strange that he would also have to pay California taxes on that unearned income.  Any help or ideas would be greatly appreciated.

Thank you!

[hbl3973]

taxmom50,

Hold tight while I see if I can track down a different thread from a couple years back where the taxpayer had a very similar struggle with non-CA parents.  But in the meantime, I have a question for you:

Normally 529 distributions do not show up on tax returns unless they are used for non-college expense.  See https://www.savingforcollege.com/article/what-you-can-pay-for-with-a-529-plan for the very generous list of expenses, including room and board, that qualify for 529 distribution expenses.  Did the $5K get applied to such expenses?