Scholarships and unearned income

[ryan513]

My son's scholarships exceed his educational expenses. It is my understanding that the excess would be considered unearned income and would be subject to the kiddie tax. But for some reason, TurboTax is not classifying it as unearned income and Form 8615 is not being generated. I filled out the 1098T. Why is the amount not being classified correctly? It shows up on the Wages, Salaries and Tips Worksheet as "Scholarship/fellowship income" as it should. But it does not automatically transfer over to unearned income as it should. All guidance I find online says that it should be classified as unearned income and should be subject to the kiddie tax. What am I doing wrong?

[Texas Roger]

Your son's taxable scholarship income is taxable on his tax return not yours. You should enter the 1098-T on his tax return and the taxable amount will be correctly treated as earned income with an SCH beside it on his tax return. He will get the standard deduction of $12,200 for earned income to reduce the amount of scholarship that he must actually pay taxes on if any. 

[ryan513]

I did enter it on his tax return. My confusion is when you say the taxable amount will be treated as earned income. All the guidance I have found stated that taxable scholarship income for him should be treated as unearned income, not earned income and should therefore also be subject to the kiddie tax and will generate Form 8615. Would you please tell me where you found the guidance that says it would be earned and not unearned income? Thank you!

[ryan513]

I should also add that the taxable amount of his scholarship significantly exceeds the standard deduction of $12,200.

[Texas Roger]

Unfortunately I was going from memory which may not be accurate. We have a couple of knowledgeable persons who answer on this forum who may be able to help with this:

@Hal_Al 

@Carl 

[Hal_Al]

Taxable scholarship is only treated as earned income for purposes of calculating a student-dependent's standard deduction. So, a student with more than $12,200* of taxable scholarship, will get the full $12,200 standard deduction.  Any scholarship over that amount is unearned income and  is subject to the kiddie tax.  If TurboTax is not calculating it, you've most likely entered something wrong in the personal info interview, or your student is not subject to it.  He must be an unmarried,  full time student, under 24, with less than half his support coming from his earned income.

* technicality it's 11,850, $350 less than 12,200

[Texas Roger]

I just completed a sample tax return for a 20 year old dependent who had $35,000 of scholarship income and $20,000 of tuition expenses leaving an amount of $15,000 entered with the letters SCH on line 1 of form 1040. TurboTax subtracted $12,200 from the $15,000 leaving $2800 of taxable income on line 11a of form 1040.

TurboTax then uses form 8615 and 8615 line 7 computation worksheet to calculate taxes of $308. The parents name and SSN must be added to form 8615. 

So it is correct that TurboTax treats the income as earned income for the entry on form 1040 for the standard deduction amount but then uses 8615 to calculate the actual tax to account for the kiddie tax.

[ryan513]

He does fit into this category. "He must be an unmarried, under 24, full time student with less than half his support coming from his earned income." I'm not sure what I missed, but when I went in and manually checked "yes" to the box at the top that says "Form 8615 Child Age 18 to 23 Smart Worksheet", it correctly classified it as unearned income. Not sure why I had to do that manually, but it works now. Thanks for your help.

[ryan513]

I'm not sure what I missed, but when I went in directly to Form 8615 and manually checked "yes" to the box that says "Form 8615 Child Age 18 to 23 Smart Worksheet", it correctly classified it as unearned income. Not sure why I had to do that manually, but it works now. Thanks for your help.

[clobber88]

I have been able to repeat the scenario/calculation described by @Texas Roger and @Hal_Al. That is a dependent child with scholarship income over tuition and expenses. I see how the excess scholarship is treated as earned income for the purpose of filing and standard deduction. And I see how that excess income less standard deduction is treated as unearned income for the purpose of kiddie tax. However, it is my understanding that the calculation should be the same if the scenario is changed from a dependent child to independent. The kiddie tax is not tied to that status. However, TT is removing all kiddie tax when I make the filing child independent. In fact, after switching to independent TT forces me to remove any/all information from form 8615 including sames, checkboxes, and dollar amounts.

Is my understanding of independent children and kiddie tax correct? If so, how can I correct in TurboTax?

Edit: Wait - the instructions for 8615  only talks about dependent children. And the 5 tests only mention "child." Now I'm thinking this means qualifying child which is a dependent?

If that is the case, can the taxable excess scholarship count as support provided by the child for the purpose of determining they are independent?

1. The child had more than $2,200 of unearned income.

2. The child is required to file a tax return.

3. The child either:

   1. Was under age 18 at the end of 2020,

   2. Was age 18 at the end of 2020 and didn’t have earned income that was more than half of the child's support, or

   3. Was a full-time student at least age 19 and under age 24 at the end of 2020 and didn’t have earned income that was more than half of the child's support.

   (Earned income is defined later. Support is defined below.)

4. At least one of the child's parents was alive at the end of 2020.

5. The child doesn’t file a joint return for 2020.

[Hal_Al]

Q. If that is the case, can the taxable excess scholarship count as support provided by the child for the purpose of determining they are independent?

A. No. Scholarships are ignored in the support calculation, even when taxable. 

Reference: https://www.journalofaccountancy.com/issues/2011/may/20113902.html

[SULKERAY]

My question is my son's scholarship is $9, 495 and it exceeds his school expenses just $3000. If he files his own tax return and be my dependent too. He is living with us and we are paying everything. 

Help please 

[Hal_Al]

If $3000 of taxable scholarship is his only income, he does not need to file a tax return. 

You do not report his income on your return. If it has to be reported, at all, it goes on his own return. If your dependent child is under age 19 (or under 24 if a full time student), he  must file a tax return for 2021 if he had any of the following:

1.          Total income (wages, salaries, taxable scholarship etc.) of more than $12,550 (2021).
2.          Unearned income (interest, dividends, capital gains, unemployment, taxable portion of 529 distribution) of more than $1100.
3.          Unearned income over $350 and gross income of more than $1100
4.          Household employee income (e.g. baby sitting, lawn mowing) over $2300 ($12,550 if under age 18)
5.          Other self employment income over $432, including money on a form 1099-NEC

________________________________________________________________________________________

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.

[wtfl]

Thank you for all the great info on this topic. 

I'm still struggling to understand the kiddie tax and AOC ramifications of scholarship $ in excess of tuition and "qualified expenses".

Could you please clarify the loophole for claiming the AOC if dependent has scholarship that exceeds tuition?  My 19-year old's T-1098: 

Box 1 $59,500  qualified tuition and related expenses  Box 5 $81,000 scholarships 

(also has about $3500 other qualified expenses, leaving about 18K unearned income ? )

I have heard other parents claim the AOC in our situation, but I can't see how the loophole might apply in our case?  

Thanks for any additional info or guidance anyone can provide.  I guess I should go to a CPA, but I would like  to understand for myself.

[Hal_Al]

Scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $12,950 filing requirement and the dependent standard deduction calculation (earned income + $400).  It is not earned income for the kiddie tax and other purposes (EIC. IRA contributions or additional child tax credit).

Your situation:

Box 1 $59,500, Box 5 $81,000 scholarships, $3500 other qualified expenses. He has $18,000 of taxable scholarship to report.

But, if he reports $22,000 of taxable scholarship, the parents can claim $4000 of tuition for the AOC. 

Assuming he has no other income: 22,000 -12,950 Standard deduction = $9050 taxable income, $7900 (9050 - 1150) of it subject to the kiddie tax. 

The simplified entry method (workaround), in TurboTax: Enter the 1098-T on your return with $4000 in box 1 and box 5 blank. Enter no other numbers.  On his return, enter 0 in box 1 and $22,000 in box 5. Enter no other numbers.