Thanks! I certainly don't want to do anything incorrectly! I know that my kids don't have to file taxes based on their income but I thought it was encouraged in IRS Pub 970 to include scholarship in the student's income to maximize the credit. I was simply trying to follow Pub 970's sample scenario to maximize the credit. The various examples, particularly 3 under the attached section, are what I was trying to understand as pertinent to my situation. I don't mind the extra step of having my kids file taxes if it helps us correctly maximize the AOTC.
Thanks.
https://www.irs.gov/publications/p970
Coordination with Pell grants and other scholarships.
You may be able to increase your American opportunity credit when the student (you, your spouse, or your dependent) includes certain scholarships or fellowship grants in the student's gross income. Your credit may increase only if the amount of the student's qualified education expenses minus the total amount of scholarships and fellowship grants is less than $4,000. If this situation applies, consider including some or all of the scholarship or fellowship grant in the student's income in order to treat the included amount as paying nonqualified expenses instead of qualified education expenses. Nonqualified expenses are expenses such as room and board that aren't qualified education expenses such as tuition and related fees.
Scholarships and fellowship grants that the student includes in income don't reduce the student's qualified education expenses available to figure your American opportunity credit. Thus, including enough scholarship or fellowship grant in the student's income to report up to $4,000 in qualified education expenses for your American opportunity credit may increase the credit by enough to increase your tax refund or reduce the amount of tax you owe even considering any increased tax liability from the additional income. However, the increase in tax liability as well as the loss of other tax credits may be greater than the additional American opportunity credit and may cause your tax refund to decrease or the amount of tax you owe to increase. Your specific circumstances will determine what amount, if any, of scholarship or fellowship grant to include in income to maximize your tax refund or minimize the amount of tax you owe.
Example 1—No scholarship.
Bill, age 28 and unmarried, enrolled full-time in 2024 as a first-year student at a local college to earn a degree in law enforcement. This was Bill’s first year of postsecondary education. During 2024, Bill paid $5,600 for qualified education expenses and $4,400 for room and board for the fall 2024 semester. Bill and the college meet all the requirements for the American opportunity credit. Bill's adjusted gross income (AGI) and MAGI, for purposes of figuring the credit, are $38,100. Bill claims the standard deduction of $14,600, resulting in taxable income of $23,500 and an income tax liability before credits of $2,591. Bill claims no credits other than the American opportunity credit. Bill figures the American opportunity credit based on qualified education expenses of $4,000, which results in a credit of $2,500 and a tax liability after credits of $91 ($2,591 − $2,500).
Example 2—Scholarship excluded from income.
The facts are the same as in Example 1—No scholarship, except that Bill was awarded a $5,600 scholarship. Under the terms of the scholarship, it may be used to pay any educational expenses, including room and board. If Bill excludes the scholarship from income, it will be deemed (for purposes of figuring the education credit) to have been applied to pay tuition, required fees, and course materials. Bill’s adjusted qualified education expenses would be zero and there would be no education credit. Therefore, Bill's tax liability after credits would be $2,591.
Example 3—Scholarship partially included in income.
The facts are the same as in Example 2—Scholarship excluded from income. If, unlike Example 2, Bill includes $4,000 of the scholarship in income, the $4,000 will be deemed to have been applied to pay for room and board. The remaining $1,600 of the $5,600 scholarship would reduce the qualified education expenses, and the adjusted qualified education expenses would be $4,000. Bill's AGI and MAGI would increase to $42,100, the taxable income would increase to $27,500, and the tax liability before credits would increase to $3,071. Based on the adjusted qualified education expenses of $4,000, Bill would be able to claim an American opportunity credit of $2,500 and the tax liability after credits would be $571 ($3,071 − $2,500).
