help needed on scholarship income and QTP

[slrg411]

I've been scouring the TT Community for help and see a lot of related responses, but I'm still confused with all the info. I filed an extension for 2022 due to my confusion as it relates to my daughter's college expenses, scholarships and her QTP. And and I am thinking I might need to amend 2021 while preparing to file for 2022.

In Fall 2021, my daughter was a college freshman. She received $8000 in scholarships - $3500 from the university, $2000 from local groups that was sent directly to the university and $2500 from local groups that was given directly to her. She also received $2721 in a FAFSA loan (half the amount awarded) and has a QTP that we paid for.  In addition, she worked in the summer of 2021, making $2272.

Here's what I did on my 2021 taxes:

My husband and I claimed her as a dependent on our taxes.

We entered her 1098-T and 1099-Q info on our taxes and claimed her education expenses (**at the time, only books and supplies of $99).

Box 1 of 1098-T = $11731

Box 5 of 1098-T = $5500

Box 7 "...includes amounts for an academic period beginning Jan-Mar 2022" = it was checked

Other scholarships not included = $2500 in local scholarships given directly to my daughter (not included on parents original 2021 tax filing)

Box 1 of 1099-Q = $5433

Box 2 of 1099-Q = $1608

Box 3 of 1099-Q = $3825

We (parents) qualified for the AOTC and received $2436.

We did NOT file a tax return for her because, based on what I had read and thought I understood at the time, she didn't need to file a return because she made less than the standard deduction.

As I started to file my 2022 taxes, I stopped because as I researched more, I felt like I hadn't done the 2021 taxes correctly as it relates to all her college stuff. I decided I might need to file a 2021 return for her after all, which might mean an amendment to mine.

1) If I go back and file a 2021 tax return for my daughter,  where do I include  the $2500 in local scholarships given directly to her?

@Hal_Al - I read in one of your other posts that it would be considered as earned income for her standard deduction and unearned income for the "kiddie tax", but I still wasn't certain where to enter it in TT.

Do I include under Wage & Income/Less Common Income/Miscellaneous Income? And then do I also include it under Deductions & Credits/Education/Expenses & Scholarships/Scholarships & Grants/Other Scholarships & Grants?

OR...do I include all or part of it on my taxes?

**NOTE - I realized that I should have included Room & Board expense of $5013 with the education expenses on my taxes for 2021 but was confused thinking that expense was part of the total payments/financial aid received by the university (in Box 1 of 1098-T) and it looked like I was "double dipping". Now I know it wasn't included.

2) My other concern is that on the 1098-T for 2021, the payments received in Box 1 included funds from the QTP for the Spring 2022 classes. Box 7 was checked, and luckily I have the breakdown of exactly was paid for Spring ($5248). I just want to make sure how to handle this.

Should I enter that amount for Spring under Deductions & Credits/Scholarships & Grants/Did Your Aid Include Amounts Not Awarded for 2021 Expenses? Do I enter it on just my daughter's tax return or on mine too?

Thank you so much for your time!

[tagteam]

I'm going to page Champ @Hal_Al for this question.

[NCperson]

@slrg411 - @Hal_Al is certainly the expert and he'll give a great answer.

remember how this works - and it does confuse a lot of people but for your daughter it is fairly simple:

• your daughter's scholarships are all taxable income to her HOWEVER and this is a BIG HOWEVER
• that income is reduced dollar-for-dollar by the Qualified Educational Expenses (which exceeds the $8,000 in this case)

given that,  why do you think your daughter has to file a tax return? 

[Hal_Al · Accepted solution]

Q. If I go back and file a 2021 tax return for my daughter,  where do I include  the $2500 in local scholarships given directly to her?

A. First you need to determine if it is taxable.  Scholarships are tax free if used for qualified expenses (tuition, fees and course materials).  This means you need to allocate expenses to the three sources of funds (scholarships, QTP, and personal funds [including loans]) to determine if any of the scholarships are taxable. Expenses allocated to personal funds can be used to claim the tuition credit. 

Q. Do I include under Wage & Income/Less Common Income/Miscellaneous Income? 

A. No.  If any of the scholarship is taxable, it's entered in the education section to be sure it's taxed as scholarship (earned income). So. it's entered under Deductions & Credits/Education/Expenses & Scholarships/Scholarships & Grants/Other Scholarships & Grants.  Entering it is complicated. 

Q. OR...do I include all or part of it on my taxes?

A. No.  A student dependent's income is never entered on the parent's return (there is a minor exception: If his only income is from interest and dividends, Alaska PFD or capital gains distributions shown on a 1099-DIV, there is an optional provision for entering it on the parent's return, using form 8814. ). 

A cursory analysis of your numbers indicates that only a small portion of her scholarship may be taxable.  Even if the full $2500 was taxable, it would not be enough to require he to file a return ($2500 + $2272 is still less than her standard deduction). 

See my standard write up on 529 distributions below the line.

________________________________________________________________________________________

Qualified Tuition Plans  (QTP 529 Plans) Distributions

General Discussion

It’s complicated.

For 529 plans, there is an “owner” (usually the parent), and a “beneficiary” (usually the student dependent). The "recipient" of the distribution can be either the owner or the beneficiary depending on who the money was sent to. When the money goes directly from the Qualified Tuition Plan (QTP) to the school, the student is the "recipient". The distribution will be reported on IRS form 1099-Q. 
The 1099-Q gets reported on the recipient's return.** The recipient's name & SS# will be on the 1099-Q.
Even though the 1099-Q is going on the student's return, the 1098-T should go on the parent's return, so you can claim the education credit. You can do this because he is your dependent.

You can and should claim the tuition credit before claiming the 529 plan earnings exclusion. The American Opportunity Credit (AOC or AOTC) is 100% of the first $2000 of tuition and 25% of the next $2000 ($2500 maximum credit). The educational expenses he claims for the 1099-Q should be reduced by the amount of educational expenses you claim for the credit.
But be aware, you can not double dip. You cannot count the same tuition money, for the tuition credit,  that gets him an exclusion from the taxability of the earnings (interest) on the 529 plan. Since the credit is more generous; use as much of the tuition as is needed for the credit and the rest for the interest exclusion. Another special rule allows you to claim the tuition credit even though it was "his" money that paid the tuition.
In addition, there is another rule that says the 10% penalty is waived if he was unable to cover the 529 plan withdrawal with educational expenses either because he got scholarships or the expenses were used (by him or the parents) to claim the credits. He'll have to pay tax on the earnings, at his lower tax rate (subject to the “kiddie tax”), but not the penalty.

Total qualified expenses (including room & board) less amounts paid by scholarship less amounts used to claim the Tuition credit equals the amount you can use to claim the earnings exclusion on the 1099-Q. 
Example:
  $10,000 in educational expenses(including room & board)

   -$3000 paid by tax free scholarship***

   -$4000 used to claim the American Opportunity credit

 =$3000 Can be used against the 1099-Q (on the recipient’s return)

Box 1 of the 1099-Q is $5000

Box 2 is $2800

3000/5000=60% of the earnings are tax free; 40% are taxable

40% x 2800= $1120

There is  $1120 of taxable income (on the recipient’s return)

**Alternatively; you can just not report the 1099-Q, at all, if your student-beneficiary has sufficient educational expenses, including room & board (even if he lives at home) to cover the distribution. You would still have to do the math to see if there were enough expenses left over for you to claim the tuition credit. Again, you cannot double dip!  When the box 1 amount on form 1099-Q is fully covered by expenses, TurboTax will enter nothing about the 1099-Q on the actual tax forms. But, it will prepare a 1099-Q worksheet for your records, in case of an IRS inquiry.

On form 1099-Q, instructions to the recipient reads: "Nontaxable distributions from CESAs and QTPs are not required to be reported on your income tax return. You must determine the taxability of any distribution." 

***Another alternative is have the student report some of his scholarship as taxable income, to free up some expenses for the 1099-Q and/or tuition credit. Most people come out better having the scholarship taxable before the 529 earnings. 

[slrg411]

I thought I should file a tax return for my daughter because of her scholarships - I read the taxable amount should be filed under her, not me. Can I count all $11,731 in Box 1 of 1098-T as Qualified Educational Expenses, even though only $6401 of it was for the Fall 2021 classes and the remainder ($5330) is for Spring 2022?

[Hal_Al · Accepted solution]

Q. I thought I should file a tax return for my daughter because of her scholarships?

A. No. Scholarships are only reportable if you know some of it is taxable.  Even then, it does not need to be filed, if she is under the filing threshold (her standard deduction).*

Q. I read the taxable amount should be filed under her, not me?

A. That's correct.

Q. Can I count all $11,731 in Box 1 of 1098-T as Qualified Educational Expenses, even though only $6401 of it was for the Fall 2021 classes and the remainder ($5330) is for Spring 2022?

A. Yes. Under the rules, expenses for the first term of 2022, if actually paid in 2021, are eligible for 2021 tax attributes. 

*There are times when you want the student to file a tax return, even when they technically don't have to, to document the reporting of scholarship income.  The usual situation is this: the family didn't actually pay any tuition (because it was all paid by scholarship) but are otherwise eligible for the tuition credit.  By the student declaring some of his scholarship as taxable, it frees up tuition for the parents to claim the credit.  See explanation below the line.  In your case, the taxable amount of scholarship is so small (if any) that going to the trouble of filing a tax return.  documentation is not recommended. 

Theoretically, TurboTax (TT) can calculate the taxable amount of her scholarship. In actuality, it's  complicated, an it's best if you have some idea of the taxable amount before trying to enter it. 

_____________________________________________________________________________________________

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 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 school’s billing statement specifically shows the scholarships being applied to tuition or if the conditions of the grant are that it be used to pay for qualified expenses.

Using an example: Student has $10,000 in box 5 of the 1098-T and $8000 in box 1. At first glance he/she has $2000 of taxable income and nobody can claim the American opportunity credit. But if she reports $6000 as income on her return, the parents can claim $4000 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, she would only need to report $5000 of taxable scholarship income, instead of $6000.

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”.

[slrg411]

I've read and reread this information you provided and I think I finally get it. And thank you for the information on the follow up questions. I appreciate it!