American Opportunity Credit and Scholarship

[Janetg1]

My 21 year-old daughter is a full-time college student and pays her own expenses from scholarship proceeds so I do not claim her as a dependent. She has no earned income. Her scholarship total in 2022 was $32,000. Her tuition totaled $12,000. She spent $12,000 on room and board.  So she has to pay tax on her scholarship proceeds of $20,000, that did not go toward tuition. I don't want her to miss out on the American Opportunity Credit. If she increase her taxable income to $24,000 (so she's paying tax on $4,000 that went to tuition), can she claim the AOC? 

(She received a 1098-T, hasn't taken the AOC before, is working on a degree and isn't a felon.) 

And if it is possible for my daughter to claim the AOC, how to I get Turbo Tax to do this? 

[Vanessa A]

If she increase her taxable income to $24,000 (so she's paying tax on $4,000 that went to tuition), can she claim the AOC?   How will she increase her taxable income?  You are not allowed to manipulate income to lower it or increase it.  You  must report all income as it was received. 

Scholarship income does not count when figuring out the American Opportunity Tax Credit, so if this is her only income, she is not eligible for the credit.  

Also, scholarship income does not count as her providing more than half of her own support.  This means, you may still be able to claim her as a dependent.  

Here is a link with more information on a child under 24 claiming the AOTC and "supporting" themselves. 

[Janetg1]

Thank you for your reply VanessaA. This is still very confusing to me. 

It was my understanding that all or some of certain tax-free scholarships could be included in a student's income in order to treat the included amount as paying nonqualified expenses instead of tuition. This would be done in order to increase the student's qualified education expense for the American Opportunity Credit up to $4,000. 

You said that my daughter doesn't qualify for the AOC because her scholarship is her only income. 

If in my case, I decide to claim my daughter as a dependent as you mentioned, can I claim the American Opportunity Credit (if I'm within the income limit)? 

[Vanessa A]

It depends.  If the scholarships are in excess of tuition,  you generally cannot claim an education credit for tuition that was paid for with tax free money.  

However, if she would increase the amount of the scholarships considered to be taxable income, it would be possible for you to claim the American Opportunity Tax Credit if you are within income limits. The best thing to do is to play around with the numbers.  See how adding the credit to your return helps you vs increasing her taxable income. 

The reason she would not qualify is because scholarship income does not count towards her providing her own support.  This means she would still qualify as a dependent.  Since she would still qualify as a dependent, she would only be eligible for the non-refundable portion of the AOTC.  So basically, she would be increasing her taxable income to decrease her tax liability but would have no actual benefit in doing so. 

[Devon13]

Hi Vanessa (and Janet),

I am facing a similar scenario -- a child on a full-ride scholarship, and I'd like to take advantage of the AOTC via the IRS-suggested way of allocating up to $4k in scholarship funds as income on my child's return (instead of allocating it towards the expense of tuition, which would make it tax-free), and then claim the $4k towards the AOTC on my own return.  All of the IRS and other published examples are seemingly for non-full-ride scholarships, though many examples do indeed show scenarios where the scholarship exceeds qualified expenses (tuition, fees, books) by a considerable amount.  I'm just not sure whether additional expenses need to be left "unspoken for" in order to shift the allocation around, nor whether those expenses need to all have been accounted for by the university.  It isn't clear to me from your answer to the original poster (whose child appears to have earned a similarly large scholarship) whether the AOTC optimization strategy (which the IRS itself advocates for) can be applied in the setting of a full-scholarship, which results in no additional non-scholarship funds received by the university.  The IRS publications on the topic state that the taxpayer can allocate the funds in a different manner than the university chose to, but they do not appear to clearly address whether there needs to be room left in the "unqualified expenses" bucket to execute this allocation.  Given that the IRS also shows that payments made by a third party can be claimed by as payments made by the student (or parent), and acknowledges that the cost of attendance (COA) given by the university is just an estimate, and the 1098-T is just for guidance (a tax filer does not need to claim to have allocated their scholarship or grant funds in a manner consistent with the 1098-T reporting, as I understand it), it appears to me that the IRS guidance leaves room to take advantage of the AOTC even with a full-ride scholarship.  However, I'm not an accountant, so I'd love to hear an expert weigh in on the topic.

[Carl]

First, take note that there is no requirement for the parent(s) to provide the student any support. Not one single penny. The support requirement is on the student, and only the student.

There are only two possible ways a student can lay claim to providing more than half of their own support.

1) The student has a W-2 job or is self employed and earned enough money to justify a claim to providing more than half of their own support. Additionally, that earned income must be more than the total of all third party income received during the tax year. Scholarships, grants, 529 distributions, gifts from Aunt Mary, money from parents, etc. are all third party income sources, and *do not count* for the student providing their own support.

2) The student (not the parent) is the *primary* borrower on a "qualified" student loan, and sufficient proceeds from that loan were distributed to the student during the tax year to justify a claim to providing more than half of their own support. Additionally, the amount distributed from the loan to the student during the tax year must be more than the total of all third party income received during that tax year. Scholarships, grants, 529 distributions, gifts from Aunt Mary, money from parents, etc. are all third party income sources, and *do not count* for the student providing their own support. 

[Hal_Al · Accepted solution]

Q. It appears to me that the IRS guidance leaves room to take advantage of the AOTC even with a full-ride scholarship?

A.  Yes.  You can do what you propose to do. 

Q. I'm just not sure whether additional expenses need to be left "unspoken for" in order to shift the allocation around, nor whether those expenses need to all have been accounted for by the university?

A. You claim the tuition credit, or report scholarship income, based on your own financial records.

As you apparently know, There is a tax “loop hole” available, and the IRS encourages use of the loop hole.  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.

[Devon13]

Thank you, this answers my question and is very helpful!

[ntax0]

Dear Hal_AI,

Thanks so much for your helpful reply! If you have a moment, would you be willing to elaborate on the following quote:

"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."

I ran into a quote from an IRS publication and would like to reconcile the two: "Student may allocate scholarships to living expenses (up to the amount of actual living expenses) regardless of how their school treats their Pell grant or other scholarship." 

A student's university scholarship seems to be listed as either consuming all tuition and part of room and board (or vice versa).

Excess scholarships are disbursed to the student from the university via a refund. Do you feel I'd be able to use the strategy in this case for the portion of the scholarship allocated to tuition? For instance, could I shave $2,000 off the amount of scholarship money spent for tuition and count it as income as long as that scholarship can be used for qualified and unqualified expenditures? 

If so, would the way I input scholarship money I received for nonqualified expenses on my tax forms change, or would I only increase my taxable income by the amount necessary to reach $4,000 in qualified expenditures and leave everything else unchanged?

Thank you!

[Hal_Al]

Q. Please elaborate on the following quote:

"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."

A. The main point is that you may not shift scholarship money if the terms of the grant are that it be used for tuition.  The billing statement comment was meant only as a possible indication of what the terms might be. The billing statement does not govern, only  the actual terms of the scholarship.

Q. A student's university scholarship seems to be listed as either consuming all tuition and part of room and board (or vice versa). Do you feel I'd be able to use the strategy in this case for the portion of the scholarship allocated to tuition? 

A.  That's not clear. But, no, if the conditions of the scholarship are that a certain amount must go to tuition. 

Q. If so, would the way I input scholarship money I received for nonqualified expenses on my tax forms change?

A. None of that is done on the actual tax forms.  It occurs in the TurboTax (TT) interview.

Q. Or would I only increase my taxable income by the amount necessary to reach $4,000 in qualified expenditures and leave everything else unchanged?

A.  In the TT interview, you will be asked how much of the scholarship went for room & board. That's how you shift the scholarship to nonqualified expenses. 

If you are the parent, you have to make the adjustment on both your return (to re-allocate expenses to the tuition credit) and the student's return (to report the scholarship income).  

[ntax0]

Thanks!