Question on Education Tuition and Fees Deduction 1098-T Dependent

[MikSek]

(Note: Using rounded numbers for ease of calculation)

Hello community!

I'm preparing a 2020 1040x amended return and would appreciate some direction regarding the Tuition and Fees Deduction. This was my dependent's fifth tax year in college (four academic years 2016-2020) so I'm unable to apply the American Opportunity Credit (which in full transparency was the error I made for 2020 that I need to rectify, which is why I'm here). 

My dependent's 2020 1098-T states:

Box 1 = $5,500 - I paid for all tuition and have a letter from the university documenting the five payments received by me totaling $6,000 and the specific portions of those individual payments allocated to qualified tuition and expenses totaling $5,500.

Box 5 = $5,000 - A grant specific to university housing as a dorm RA, which the account statement I have from the university aligns with (line item "UHS_RA CA housing - $5,000 Credit") and as I understand it is a non-qualified expense.

Turbo Tax indicates the non-qualified $5,000 grant specifically used for housing will need to be counted as income on my dependent's return (so at this point presuming they'll also need to amend their 2020 income of $10,000 wages plus the additional $5,000 as "other income").

However, I received conflicting direction from the IRS, in that they stated the $5,000 non-qualified for housing would be reduced from my $5,500 qualified tuition expense (which would result in a deduction on my amended form of only $500). Also, that if instead of this reduction on my tax return, my dependent were to add this $5,000 to their income instead, they would not be able to use the standardized deduction ($12,400 in 2020) and be taxed on the full amended amount (in this case $15,000) 

I've seen in various threads here in the community with examples where a grant exceeds the qualified expenses, but not one where a non-qualified grant is less than qualified expenses (and specifically in my instance, with conflicting instructions from the IRS regarding who's tax return it should be entered on: the parent's or the dependent's).

Your direction would be truly appreciated. Thanks!

[MikSek]

@Carl & @AmyC, tagging you for visibility based on your comments and insight on a separate related thread. Thanks! 

[MichaelG81]

If amending a different year, return for the AOTC, you may still qualify for the Lifetime Learning Credit LLC. Generally, scholarship income doesn't become taxable until Box 5 is greater than Box 1 of your 1098T or you put unqualified expenses like room and board.

Try putting qualified expenses for your 1098T. It may tax you for unqualified expenses.

@MikSek 

[Carl]

Maybe this will help. Bear with me while I state the obvious as confirmation I"m on the same page as you.

Box 1 of the 1098-T shows all funds received by the college from all sources and applied to "qualified" education expenses. The only qualified expenses are tuition, books, and lab fees. That's it; but "lab fees" is a rather broad category. Still, that category does not include room and board.

Box 5 shows all third party income received by the college from all third party sources. It would include grants, scholarships, as well as funds credited by the school for any reason, including RA duties. It does not include out of pocket expenses.

If the data is entered in the program "as is", the IRS applies things in a specific order.  (This is a boiler, so bear with the "repeats" from above.) Line numbers referenced may be different, since you're dealing with a 2020 tax return.

 First, scholarships & grants are applied to qualified education expenses. The only qualified expenses for scholarships and grants are tuition, books, and lab fees. that's it. If there is any excess, then it's taxable income. It automatically gets transferred to and included in the total on line 7 of the 1040.

Next, 529/Coverdell funds reported on 1099-Q are applied to qualified education expenses. The qualified expenses for 1099-Q funds are tuition, books, lab fees, AND room & board. That's it. If there are any excess 1099-Q funds they are taxable. The amount is included on line 8z of the SCH 1 which gets transferred to line 8 of the 1040.

Finally, out of pocket money is applied to qualified education expenses

When you have a 1099-Q it is extremely important that you work through the education section of the program in the order it is designed and intended to be used. If you do not, then there is a high probability that you will not be asked for room & board expenses, and you could therefore be TAXED on your 1099-Q funds.

Finally, if "all" qualified expenses are covered by scholarships, grants, 1099-Q funds and there is ANY of those funds left over, the left over excess is taxable. While the parent can still claim the student as a dependent, it is the student who will report all the education stuff on the student's tax return. That's because the STUDENT pays the taxes on any excess scholarships, grants and 1099-Q funds.

Now there are "ways" to do things which are perfectly legal, so that one can qualify for a credit (such as the AOC) by making all or a portion of the box 5 amount taxable. But I really don't know the details of that now-a-days, as my kids finished college about 10 years ago. Lots of things on the tax front have changed over that time.

[MikSek]

@MichaelG81 

Re: LLC, per TurboTax program I'm unable to use LLC due to income criteria so program automatically selected Tuition and Fees Deduction as best option to maximize tax breaks.

Re: your comment "Try putting qualified expenses for your 1098T. It may tax you for unqualified expenses." I'm not understanding your direction. Box 1 is Qualified tuition (I paid), Box 5 is Unqualified grant based on description (university paid for housing).

So with that in mind, my primary question is: Turbo Tax is instructing me that I can deduct the full $5,500 qualified expenses from Box 1 and my dependent is responsible for reporting the $5,000 grant from Box 5 a) if they exceed education expenses (it doesn't) OR b) if the money was used to pay for non-qualified expenses (it was, for housing).  But the IRS is saying the $5,500 qualified expenses are to be reduced by the $5,000 unqualified expenses on my own tax return (which contradicts Turbo Tax). 

Hopefully that helps clarify my question and need? Understanding it's difficult to comprehend all the details of a specific situation in a forum 🙂 Thank you!  

[MikSek]

@Carl

Appreciate the thorough response. Essentially any excess is taxable, which I totally get.  But in my instance the grant (which per the description in Turbo Tax was dedicated to a non-qualified expense) is LESS than the qualified expenses. 

So my primary question/quandary is this:

• The Turbo Tax program is instructing me that the full $5,500 from Box 1 I can be deducted as qualified expenses on my tax return, and that my dependent is responsible for reporting the $5,000 from Box 5 as other income on their tax return a) IF they exceed education expenses (which it it doesn't) - OR - b) if the money was used to pay for non-qualified expenses (which it was, for housing). 
• But the IRS is saying the Box 1 $5,500 qualified expenses are to be reduced by the Box 5 $5,000 housing grant (specifically described by Turbo Tax in this instance as an unqualified expense) on my own tax return, which contradicts Turbo Tax. 

Hopefully that helps clarify the contradiction I'm looking to resolve.

Understanding it's difficult to comprehend all the details of a specific situation in a forum. I may just take the adventure into my local Tax Assistance Center since while the IRS support over the phone has been pleasant with acceptable hold times, each time I call I uncover yet another layer that spawns another set of questions/confusion/contradictions.

Thanks for your help!  

[Hal_Al]

The people at the IRS told you wrong.  You do not HAVE TO reduce the box 1 amount by the box 5 amount.

Just enter the the 1098-T with $5500 in box 1 and box 5 blank.

The Tuition and Fees deduction is limited to $4000 (for some income levels $2000).  But TT will handle that.

If your student had $10K of other income and did not report the $5000 of non qualified scholarship, as income, you are correct he needs to also file an amended return. It is not reported as "other income".  It is reported as SCH on line 1 of form 1040. As such, it is earned income and will increase his standard deduction. 

[maglib]

@MikSek 

- first the question about did he finish 4 years... you should answer NO.  He may have done 4 years of college but, they didn't complete their 4 year degree.

-There may be a benefit for your student to claim the education credit and claim the entire 1098T depending on their income level.  If they are your dependent, they do not though get a full standard deduction. The standard deduction for dependents is limited to either $1,100 or the dependent's earned income plus an additional $350, whichever figure is greater.  This is only a benefit if you are a high income taxpayer where you may not get the benefit of them as a dependent. It would be you don't claim them, they can not claim themselves unless they covered over 50% of their expenses with earned income.  you would have to try the different scenarios out.  If they do not claim themselves, they can reduce their taxes owed to the extent of the tax credit for education.  They also then could possibly open an IRA to the extent of their earned income and start saving for retirement early.

So now on the 1098-t front if you do claim it.  The truth is what you fill in is not even reported to the IRS.  you can just put in the total expenses, don't forget you have books and other items to add that were needed for attending.   Only the Form 8863 will go to the IRS.   

Save different versions but, you most certainly can just claim the net amount and forget about following the interview.  Or take the total expense and let your student claim the income.  Sometimes TT is finicky and you need to work around it.  Use whatever version of claiming the income and expense works best between you and your student.  

[MikSek]

@Hal_Al 

Unfortunately I can't "undo" Box 5 as blank in TT as it's already been submitted as such with my initial return (when I had incorrectly claimed the AOC for a 5th year) and my amended return (which in place of the AOC I instead was able to claim the Tuition and Fees Deduction per TT program). At this point I'm working with the IRS exams to try and support my original amended return based on TT output. 

However I did try a similar approach in to what you recommended in TT and interestingly for the question "Did your student pay for Room and Board with a Scholarship or Grant?", instead of keeping it "Yes" as was done on my initial and for my amended return, if I re-check the box as "No"  it increases my tax to the same amount the IRS calculated I would need to pay if the Box 1 $5,500 qualified tuition expenses were reduced by the Box 5 $5,000 non-qualified grant dedicated for housing. So somewhere a calculation is occurring that aligns between what the IRS provided me and with TT when this box is incorrectly checked "No" (which is perhaps what the IRS had mistakenly selected in their system, based on the initial support docs I had sent?)

Unless you or someone in the community can provide me with an "a-ha" moment, this is likely going to require a face-to-face with documents in-hand at the IRS Taxpayer Assistance Center.

Thanks Hal, appreciate the help!

[MikSek]

@maglib 

Similar to my response above to Hal, unfortunately I can't "undo" anything from 2020 as it's already been submitted as such, both with my initial return (when I had incorrectly claimed the AOC for a 5th year) and my amended return (which in place of the AOC I instead was able to claim the Tuition and Fees Deduction per TT program). At this point I'm working with the IRS exams to try and support my original amended return based on TT output. 

To address a couple of assumptions you made about the student:

• They did finish all 4 years and complete their degree in 2020, so answering "no" isn't accurate (unless I'm missing something?)
• They did check the box "Someone else can claim me as a dependent" on their tax return for 2020 and the itemized deduction looks to be the calculation you'd expected: Income + $350 (again this is 2020). FYI they did use TT Online Version

I do like the idea of them opening an IRA but we'll need to see what transpires if/when we calculate what their taxes would be if they were to submit their amended return with the additional income from the grant.

Thanks! 

[maglib]

@MikSek  the question is "Did the student complete the first 4 years of postsecondary education BEFORE 2020?"  The answer is NO.    He was still in school in 2020.

I gave you the standard deduction for 2021.  For both 2019 and 2020, the standard deduction for dependents is the larger of $1,100 or the sum of the dependent's earned income plus $350 (no greater than the std deduction of course.  So if he claims the $5k in income, he may have no tax liability still..

It is sadly too late though to claim and IRA for 2020...  I was not thinking.  It is something for others who may read the thread.

You would have to post a redacted 8863 to see what is going on.   Possibly the IRS letter with it.  Redact all personal information.

[Hal_Al]

 There is a tax “loop hole” available. 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 (or TFD in your case) on their return. They can do this because that much tuition was no longer paid by "tax free" scholarship. In your case it's not even a loop hole, the scholarship was always taxable. 

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”.

Your student is going to owe about $260 ($15,000 - 12,400 x 10%) on the additional income.  Assuming you're in the 22% bracket, a $4000 deduction is worth $880; a $2000 deduction only $440. 

[MikSek]

Hi @maglib

Re: "Did the student complete the first 4 years of postsecondary education BEFORE 2020?"  The answer is No.

Just reviewed and affirmed, that is how I had answered it. There was another question asking "Was your student working on...in 2020" that I had answered "Yes" to, so I'd convoluted the two in my head.

Thanks!