Scholarships and unearned income

[wtfl]

Wow!  Thanks, Hal_Al! So appreicate you taking the time for detailed explanation.

I will follow your directions exactly for entering T-1098 info on my return and on my son’s.

Apologies if I am obtuse with these two follow-up clarification questions.

1a) So, I think I get it:  

Basically, I (parent) simply add $4000 to whatever the taxable portion of scholarship would be and pay the unearned income tax ramifications of that extra $4000 on dependent’s return so I can take the AOTC on my return.

(I had been interpreting the T-1098 as document to transcribe literally, box for box)

1b) Yet I’m still struggling to fathom the “why” the workaround works.

Is it that I’m essentially volunteering to pay more tax on my son’s return in order to claim that AOTC on my return?

If so, I’m still not clear how / why it’s legit for tax purposes to claim the AOTC when I did not actually pay the university $4000 of qualified expenses, since most were covered by his scholarship?

I trust your guidance. I’ve read many of your posts and am convinced you are the guru of this topic!  Yet I have to understand the “why” in order to feel ok using the workaround and claiming the credit.

2) If my son also has approx. $8000 of earned income (W-2 or NEC),

Does additional earned income impact the workaround?

Thanks, again, for your most kind and generous help, Hal_Al!

[Hal_Al]

Q.  Basically, THE STUDENT simply adds $4000 to whatever the taxable portion of scholarship would be, ON HIS RETURN, and pays the unearned income tax ramifications of that extra $4000 on dependent’s return so I can take the AOTC on my return.

A. Yes

Q. I had been interpreting the T-1098 as document to transcribe literally, box for box?

A. No. The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return. You claim the tuition credit, and report scholarship income, based on your own financial records, not the 1098-T. The 1098-T that you enter in TT is not sent to the IRS. 

Q. Yet I’m still struggling to fathom the “why” the workaround works. Is it that I’m essentially volunteering to pay more tax on my son’s return in order to claim that AOTC on my return?

A. Yes. You are re-allocating the tuition from the scholarship to the credit. You're allowed to do that. 

Q. If so, I’m still not clear how / why it’s legit for tax purposes to claim the AOTC when I did not actually pay the university $4000 of qualified expenses, since most were covered by his scholarship?

A. Before the reallocation, the tuition was being paid by tax free scholarship. After the reallocation, it's being paid by your son's taxable income, so you can put it on your return because the family has effectively paid the tuition. 

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”.

Q.  If my son also has approx. $8000 of earned income (W-2 or NEC). Does additional earned income impact the workaround?

A. No, but $8000 more of the scholarship will be subject to the kiddie tax.  The wage income is covered by the standard deduction, rather than the scholarship. 

I trust your guidance. I’ve read many of your posts and am convinced you are the guru of this topic!  Yet I have to understand the “why” in order to feel ok using the workaround and claiming the credit.

2) If my son also has approx. $8000 of earned income (W-2 or NEC),

Does additional earned income impact the workaround?

[Bbiernat]

If box 5 is 44000 and box 1 is 32500 can a parent file 1098t under their form for 1450 bringing the amount up to the standard deduction for the student if the parent paid qualifying expenses?  Or does it just work if the amount is over the standard deduction?

[Hal_Al]

Q. If box 5 is 44000 and box 1 is 32500 can a parent file 1098t under their form for 1450 bringing the amount up to the standard deduction for the student?

A. Yes. You can do that, regardless of whether you actually paid any qualifying expenses.

But, you don't want to do just $1450. You want to claim $4000 so you can get the maximum $2500 credit ( or at least $2000 to get a $2000 credit).  Your benefit out weighs the tax the student will pay for exceeding the standard deduction. The first $1150 (over the standard deduction) is not subject to the kiddie tax and only taxed at 10%.  So, maybe $2600 (1450 + 1150) rather than just $2000. 

[dana47]

this only even matters if you are trying to take a credit as a parent, right? b/c i'm phased out of all the credits so all this work around is pointless if you aren't eligible for the education credits.

[Cynthiad66]

However, if a scholarship is used for purposes other than for qualified expenses, the amount is generally considered to be unearned income. This may occur, for example, if your child is awarded a scholarship for room and board.

@dana47

[NikM]

Hello Hal_AI. Thank you for your assistance and guidance here. Appreciate the generosity! 

I am parent with a son who just entered as a freshman at a local university in my state. We are lucky to have received abundant scholarship in his case. Just want to make sure if I can/should claim AOTC - we are in similar boat, scenarios similar to the above.

1098-T box 1 - $9,700 (Qualified Tuition)  and Box 5 $18,300 (total scholarships) - leaving $8,600 in taxable scholarship and income for my son, based on my readings and your answers above. 

1) I assume this is a taxable income on his return and we do not need to add it to our income? Regardless of whether we claim AOTC or not, if his taxable income is below the standard deduction limit (< $,$13.8K), does he need to file a federal tax return. Michigan has a flat tax rate so he will have to pay state taxes on his taxable income -- so I don't know if that means he should file a federal tax return, as well if he has to file state tax return.

2) Even if we had practically no out of pocket qualified expenses, is it okay to claim AOTC (as you confirm via above example/IRS guidance)? I hope the IRS will not ask for proof of out of pocket expenses (and will accept our reshuffling of the scholarship entries to taxable/versus non-taxable).

Let's say we use $11,000 as the taxable scholarship (bump it up by $2,400 above from $8,600). I want to understand how to handle 1098-T entry on his return and our (parent's) return.  I assume IRS receives copies of 1098-T so I wonder if changing the $ figures will be against the law. 

On his federal return: Do we do the entries for 1098-T to show the taxable income? or Just show the taxable scholarship number as income? 

On our federal tax return: Obviously we will be entering the data from1098-T if we want to claim AOTC. Do we leave the 1098-T numbers and if so, how do we account for the $11,000 entry versus the actual entries on 1098-T - qualified at $9,700 and total at $18,300. And just to be clear, our out of pocket expenses we negligible (though he is a dependent and there is other non-college related expenses obviously). 

Thanks! 

[Hal_Al]

@NikM 

Facts: 1098-T box 1 - $9,700 (Qualified Tuition)  and Box 5 $18,300

You can add the cost of books and a required computer to the tuition as qualified expenses.  For purposes of doing an example, I'll assume $800 more for total qualified expenses of $10,500

Q. How do you go about claiming the AOTC on your tax return?

A. You claim $4000 of qualified expenses, on your return, for the AOTC. For simplicity, enter (on your return) a 1098-T with $4000 in box 1 and box 5 blank.  Those are the only numeric entries you need to make, in the  TT interview (there are other qualifying questions)

That means the student has $4000 less expenses to allocate to the scholarship. $18,300 - 10,500 + 4000 = $11,800 of the scholarship is taxable.  Assuming he has no other income, that is less than the $13,850 filing requirement*, so he does not even have to file a federal tax return. 

Q. Michigan has a lower filing requirement. Does that means he should file a federal tax return, as well if he has to file state tax return?

A. No.

Q. Even if we had practically no out of pocket qualified expenses, is it okay to claim AOTC (as you confirm via above example/IRS guidance)? 

A. Yes. As explained above, the IRS encourages this.  Although not necessary, some advisors recommend that the student file a federal return, even when not required to document the reporting of the scholarship as income. The simple way to do this: he enters a 1098-T with 0 in box 1 and $11,800 in box 5.  Enter no other numbers. 

Q.  I assume IRS receives copies of 1098-T so I wonder if changing the $ figures will be against the law?

A. No. You are adjusting numbers to facilitate the calculations.  What you enter, in TT,  is not sent to the IRS. Lying to TurboTax to get it to do what you want does not constitute lying to the IRS. 

*Dependents have a filing requirement of only $1250 (not $13,850 for non dependents) or their earned income + $400 (up to $13,850). Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $13,850 filing requirement and the dependent standard deduction calculation (earned income + $400).  It is not earned income for  other purposes.

[NikM]

Thank you so much @Hal_Al! Appreciate you elaborating again for my scenario. 

[jhvig]

Thanks in advance to @Hal_Al  or anyone else who knows this answer. For a couple of years, I have used the 1098-T numbers to take the AOTC credit for my college student who receives a scholarship. The scholarship shows up in the semester it is used. The college traditionally sends a statement in December itemizing their disbursements with the total amount reduced with scholarships and loans. I pay this remaining amount in the next calendar year, in January. The amount reported on the 1098-T form, as best I can tell, shows the amount parents pay, loans pay, and the Qualified expenses paid from the Scholarship in that calendar year. This year, my son decided to wait until January 2024 to sign up for classes. This meant that the amount the college contributed to his tuition was also moved to January 2024 instead of December. Now I am faced with the 1098-T showing that the expenses are higher than the scholarship. Turbotax shows we get no credit, and my son will now have to pay taxes on scholarships. Next year, I assume the 1098-T will show an extra semester of qualified expenses paid by the college but that won't really help for a credit.   Is there a different way to account this or do I have to enforce logical consequences on my procrastinating son and make him pay for the credit and taxes? Thanks in advance for your help. 

[Hal_Al]

Q.  Is there a different way to account this or do I have to enforce logical consequences on my procrastinating son and make him pay for the credit and taxes?

A. You have to go with the facts, but not necessarily the 1098-T.

The 1098-T is only an informational document. The numbers on it are not required to be entered onto your tax return. However receipt of a 1098-T frequently means you are either eligible for a tuition credit or possibly your student has taxable scholarship income. 

If you claim the tuition credit, you do need to report that you got one or that you qualify for an exception (the TurboTax interview will handle this)

You claim the tuition credit, or report scholarship income, based on your own financial records, not the 1098-T. In the 1098-T screen, click on the link "What if this is not what I paid the school" underneath box 1. You will then be able to enter the actual amounts paid. You will also reach a screen that allows you to adjust the scholarship amount for "amounts not awarded for 2022 expenses".

Or if you find it easier, just change the numbers in boxes 1& 5 to what your records show. The 1098-T that you enter in TT is not sent to the IRS.

I'm not quite following your facts ("1098-T showing that the expenses are higher than the scholarship. Turbotax shows we get no credit, and my son will now have to pay taxes on scholarships"). 

[jhvig]

 @Hal_Al Sorry I mispoke. The scholarship amount in box 5 is higher than the paid amount in box 1. The school shows their scholarship awarded for both semesters in box 5 (for both spring 2023 and fall 2023) so $37,800.  If you sign up for classes on time, the school sends a statement for the following spring semester in mid-December.  That means this payment for the spring of the following year would typically show up as a qualified payment on the previous tax year. However, because my son waited until January 2024 to sign up for classes, the amount the school is contributing on the 2023 1098-T is only for one semester instead of two. The total school payments, loans, and parent contributions are $26,882 (parent payment for spring and fall 2023, loan payment for spring and fall 2023, but school contribution for only one semester fall 2023).  I assume the amount that is typically posted as the school's contribution in December will be added to the 2024 form.  Can I adjust what the school paid as more than they did in 2023 if they didn't post it in their records until 2024? or do I lower the scholarship amount? Sorry for all of the questions. This is the third year I have done scholarships in Turbo-tax but this year because the statement is thrown off it is throwing me off. 

[wtfl]

Thanks in advance  @Hal_Al and anyone else for your guidance:

My son's T-1098 indicates 71K scholarship and only 36K qualified expenses, as he's studying abroad for spring term 2024 and paid only fall semester 2023 at his home university.

Son's scholarship pays for the qualified study abroad program, but those fees were paid January 2024 (rather than as in prior years -- always paid in December).   

He received a blank (?) T-1098 from the US-based study abroad institution. Not sure why, and they are no help.

If the scholarship T-1098 is correct, then he must pay taxes on 35K unqualified expenses for 2023, even though those funds went to spring term tuition in first week of January?  

That would also mean he will then have tuition payments for 3 semesters (2024 spring/fall +spring 2025) on his 2024 T-1098, which might complicate my claiming the AOTC for his 4th year?

I'm working to check timing of his scholarship funding to make sure the T-1098 is accurate.   

If it is, do we have any legit options to mitigate the tax hit?

Many thanks for your help!  

[AmyC]

1098-T forms are informational rather than a tax form. They can be adjusted to fit your circumstances, unlike interest earned at the bank. Unfortunately, we see a hit somewhere along the way fairly often, usually the senior year. The timing does make a difference. Scholarship income must be claimed in the year received. Education expenses are claimed in the year paid. You can claim tuition paid during 2023 to any Eligible Educational Institution - Internal Revenue Service. The blank 1098-T may show that you had additional expenses. See Qualified Education Expenses - Internal Revenue Service

 The IRS has a great brochure that explains how scholarships and tax credits interact. It states that scholarship income can be "Excluded from student’s income if used for tuition and related expenses. In this case, the scholarship must be subtracted from expenses that would qualify for the AOTC or LLC" In your case, the tuition is the following year so not currently available for AOTC or LLC. Could you fight and win?

[wtfl]

Thank you! 

Turns out when we check his university financial account, the T-1098 is wrong.  It's counting scholarship income that was not credited to his account until January 2024, which is also when we paid this spring semester. 

So my understanding is that we will be filling out the T-1098 with correct financial figures, which means only fall scholarship and qualified educational expenses will be claimed for 2023, then he will be claiming 3 semesters (spring 2024+ senior year 24/35)  of scholarship funds and qualified expenses for 2024. 

Hope the seeming payment disparities (basically 0.5 for 2023 and 1.5x for 2024) will not cause flags since we're following -- or doing our best to follow! -- Pub. 970 guidance.

Thanks, again!