Scholarships F0rm 11098-T

[briandsmith]

I have done my granddaughters taxes using TurboTax while she is on a 4-year athletic scholarship. This is her final year. It took a while with great help from the community, to input the data but all has seemed ok until this year when I got an unexpected answer. This caused me to do some checking, and I can't believe the taxes she is being asked to pay!

Scholarship income is treated as unearned. There are two numbers on the 1098-T - Scholarship and Tuition. TT computes the unearned income to be the difference between them. It then computes on two forms, one for federal (8615) the other for state (California, 3800). These forms are to force her to pay taxes determined from her parent's rates. I have personally checked the instructions; she is required to file them. I have also set up my own computation to correctly fill them in.

I have determined from this the following.

Her scholarship is in the order of $45000. Her taxes come out at about $900 for federal and $500 for CA. If she were earning the $45000. on a W2, those taxes would be much lower. I do not consider her folks very wealthy (income approximately $100000}. If she had more wealthy parents her taxes would be higher still! She is not dependent on her folk's return.

Is this reality or am I doing something wrong?

[Hal_Al]

Q. Is this reality or am I doing something wrong?

A. This is reality.

If this is her last year and you're just finding it out, it means she did it wrong for the last three years.  Amended returns are probably required and she owes back taxes.  But there is also good news. There is a tax loop hole available where the parents of students on scholarship can claim a $2500 tuition credit if the student pays just a little more tax (the family comes out $2000+ ahead). See below the line. They should file amended returns to get the other $7500. The deadline for filing 2021 amended returns is 4-15-25. 

Also, scholarships are a hybrid between earned and unearned income. It is earned income for purposes of the $14,600 filing requirement (2024) and the dependent standard deduction calculation (earned income + $450 up to $14,600 max).  It is not earned income for the "kiddie tax" (taxed at the parent's rate) and other purposes (e.g. EIC).  For grad students and post grad fellows, scholarship, stipend and fellowship income is earned income ("compensation") for IRA contributions.

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There is a tax “loop hole” available to claim an education credit, for the parents of students on scholarship. 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 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”.

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[briandsmith]

Wow. Thanks for the reply, I probably have been doing it incorrectly!

 I first will see about this year before filing amendments.  I do have a question though; how does the student declare more income (the $6000. in your example)? The only form she gets is the 1098-T ?

In all this we have assumed the AOC does not apply! I obviously have to read up on the AOC.

Then I guess another question arises; she is not a dependant6 on her parent's return, so how do they become eligible?

[Hal_Al]

Q. How does the student declare more income (the $6000. in your example)? The only form she gets is the 1098-T ?

A. Room and board are not qualified expenses for tax free scholarship (tuition, fees, books an a computer are).  In the TurboTax interview, after entering the 1098-T, you designate how much of the scholarship will be allocated to  R&B, to free up some of tuition, in box 1, to be allocated to the credit. It gets complicated. A work around is to manually calculate the amount of taxable scholarship ($6000 in the example) and enter the 1098-T with 0 in box 1 and $6000 in box 5. 

Q. She is not a dependent on her parent's return, so how do they become eligible?

A. Why is she not a dependent. Most college age students are.  Have they just elected not to claim her. If she meets the rules for being a dependent, she is not allowed to claim herself. They don't have to claim her, but she can not claim independent. 

There are two types of dependents, "Qualifying Children"(QC) and Other ("Qualifying Relative" in IRS parlance even though they don't have to actually be related). There is no income limit for a QC but there is an age limit, student status, a relationship test and residence test.

A child of a taxpayer can still be a “Qualifying Child” (QC) dependent, regardless of his/her income, if:

1. He is under age 19, or under 24 if a full time student for at least 5 months of the year, or is totally & permanently disabled
2. He did not provide more than 1/2 his own support. Scholarships are excluded from the support calculation
3. He lived with the parent (including temporary absences such as away at school) for more than half the year

So, it doesn't matter how much he earned. What matters is how much he spent on support. Money he put into savings does not count as support he spent on himself.  

With the tax law change, effective 2018, most students will get the same refund whether they claim themselves or not. The personal exemption has been eliminated and the standard deduction increased. However, she only qualifies for an education credit, if  she is  not a dependent. There are restrictions on a student, under 24, getting any of the refundable portion of the American Opportunity Credit. 

See full dependent rules at: https://turbotax.intuit.com/tax-tools/tax-tips/Family/Rules-for-Claiming-a-Dependent-on-Your-Tax-Ret...

[briandsmith]

Thanks again, you have given me a lot to think about! the questions on away for over half a year and providing self-support are difficult for me to answer, as grandpa!

I'll get to it!!

[Hal_Al]

One key element, that may have have been misinterpreted in the past:  being on scholarship is not self support. 

[briandsmith]

Surely if the scholarship includes room & board, that part is support.? I am wading thru requirements now!!!

[Hal_Al]

Q. Surely if the scholarship includes room & board, that part is support.? 

A. Yes and no.  Yes, the room and board are support. But the scholarship is not funds provided by the student. They're third party support. So, it's nearly impossible that the student provided more than half his own support. It's also possible that the parent didn't provide more than half the student's support, either.  But that doesn't matter under the qualifying child rules. 

The support test is different for each type of dependent. The support test, for a Qualifying Child, is only that the child didn't provide more than half his own support. The support test for a Qualifying Relative is that the taxpayer provided more than half the relative's support. The rules were written this way to allow the parents of students on scholarship to be able to continue to claim them as dependents. 

[briandsmith]

I really do appreciate your help on this. Please forgive me for keep coming back!

In my original question, I asked if I was correctly calculating her federal tax to be in the order of $8000. on a $45000. scholarship and I interpreted your answer to be "yes". You went on to talk about the "loophole". You have helped me with definitions of support etc. I have been through the various instructions and publications; I have not yet run TT. I am left with the following questions:

Assuming her folks can claim her as dependent, they can get back up to $2500. on their return. If she files her return with the $8000. the benefit is to save $2500. of the $8000.? If she adds to her income per your suggestion (to enable the parents to get nearer the $2500), her tax will increase? 

It still sounds to be a horrendous tax!!

Am I still missing something?

[Hal_Al]

You said her scholarship is $45,000, but I don't see where you said how much is in boxes 1 & 5 of the 1098-T. Also we need to know  her book expense and other course materials, including a computer if she purchased one in 2024.  

Q.  The benefit is to save $2500 of the $8000?

A. No. The tax on the scholarship remains , unless the numbers I just asked for change things. I think they do. I don't see where the $8000 came from. 

Q. If she adds to her income per your suggestion (to enable the parents to get nearer the $2500), her tax will increase?   

A. Yes. She will have $4000 more taxable scholarship. So she will pay $880 more tax (4000 x 22% her parent's assumed rate) in order to get her parents $2500.  And it appears that you can repeat that for the last 3 years. 

[briandsmith]

The $8000. number came from my hand calculations of 1040 and form 8615. The reason I hand calculated was that TT came up with the 8615 form but no parent numbers included. It would have let me e-file that way! When I put the parent numbers in, the $8000. is what I got! I assume I was using the right tax tables.

Since my last note I have run the parent return with the student as a dependent. I got the $2500.

I have just run the student return again from scratch and got the same as before.

On the student return there is no easy way to input the 1098-T. To do so I have to answer "yes" to scholarships but enter no data when it asks for the number. I then can get a summary identifying the school with a chance to edit. When I do that, I can input the 1098-T data. If I had put numbers in answer to the scholarship question it would merely add the two scholarship numbers!

You seem surprised by the size of the $8000, as I am. Do you think I am using incorrect tax tables?

[Hal_Al]

I still don't know what numbers we're working with.

You said her scholarship is $45,000, but how much is in boxes 1 & 5 of the 1098-T. Also we need to know  her book expense and other course materials, including a computer if she purchased one in 2024.  What other income does she have, if any. ?

Even if $45,000 is the reportable amount: 45000-14600 = 28600 x 22% = $6292 tax. 

[Hal_Al]

On entering the info on the  student's return, if you're going to use the short cut (0 in box 1 and the calculated amount of reportable scholarship in box 5), you do not enter any other numbers. So, answer no when asked if there were any other scholarships. 

That said, I suggest you review your calculations of the reportable amount with me before entering.  Basically it goes like this:

Box 5 amount minus box 1 amount minus book expenses plus $4000 = tax reportable amount of scholarship.  You add back the $4000 because the parents used that much to claim the credit (so it's no longer covered by tax free scholarship). 

[briandsmith]

The numbers in box 1 and 5 are $46155. and $17284. I have been ignoring books etc until I have got this correct. Your $6000 number is much closer to my $8000.

Please comment on my comments about putting numbers into TT and TT not calculating form 8615 correctly.

[Hal_Al]

"The numbers in box 1 and 5 are $46155. and $17284",

I'll take that to mean box 5 is $46155 and box 1 is 17284. 

$46155 - 17284 + 4000 = $32871 - 14,600 = $18,371 x 22% = $4042 tax.  That's without the book expense. 

Q. Please comment on my comments about putting numbers into TT and TT not calculating form 8615 correctly.

A. You only need to enter two numbers, 0 in box 1 at the 1098-T screen and the calculated taxable amount (32871 before books).  TT will generate form 8615 and ask you for the parents info, income and tax.  I can't explain why you're seeing anything different.