could you do this..taxing scholarships then...

[nwtaxlady]

Say taxpayer has $3,000 in qualified tuition and has $7,000 in scholarships. Then the taxpayer would have $4,000 in taxable scholarships and NO education credits.

Could you do this?

Make all $7,000 taxable scholarhips and then take an Education Credit for the $3,000 in qualified tuition?

If you run the numbers, in some cases this way would be more beneficial for the client.

But can you do it that way???

Any input would be appreciated.

[Jiggers]

Nope

I think the instructions for the 8863 show that you must net the scholarships to the education expense.

[Koss]

Disagree

Based on the type of scholarship, it may be possible to do this.

There is a very subtle and very important issue with respect to whether the terms of the scholarship place any restrictions on how the student may use the money.

See TTB page 12-7, for a discussion titled "Coordination with Other Education Benefits." This discussion contains an example that is similar, but not identical, to the one in the original post.

BMK

[FEDUKE404]

Shell game

My guess is the information on the infamous Form 1098-T might rain on your parade, especially with the box "Scholarships or grants."

As others noted, in theory the scholarship first must apply to the allowable education expenses, thus leaving nothing for any education credit consideration. The leftover would probably be taxable income.

Parents/students just love to hear that.......but I guess 'tis better to pay the tax than the tuition!

FE

[Snaggletooth]

New Refundable Credit

The new so-called "American Opportunity Credit" can result in a refundable credit.

We need to be clear on who can do what because this new credit may result in a refund for someone who has no appreciable income and zero tax.

1. Can the STUDENT claim income from scholarships on line 21 (or anywhere else) for purposes of claiming the tuition as a credit?
2. Reverse of above: Scholarships and tuition on the 1099-T must be netted together.
3. Can the PARENT of the student claim income from scholarships for purposes of claiming the tuition as a credit?

I have a sinking feeling that the answer to ALL the above is: "Maybe."

Discussion??

[Koss]

Taxable Scholarships

I'll offer a partial answer...

A scholarship that is awarded to the student is never treated as income to the parents.

In general, a college student that is a dependent of his/her parents cannot claim the education credit. The credit is claimed by the parents, even if they paid none of the tuition.

I'm not kidding. Say the kid has NO scholarships or grants. Half the tuition might be paid by student loans, taken out by the kid, for which the parents are not liable. The other half of the tuition might be paid by the kid's grandparents.

On this fact pattern, the kid may still be the qualifying child of the parents. Remember, for a qualifying child, the parents do not have to provide any support. The test is that the child must not provide more than half of his own support.

On this fact pattern, the parents are eligible to claim the education credit based on the total amount of tuition that was paid.

This example does not address the original question. I'm still working on that.

BMK

[Koss]

Election

Page 12-7 of The Tax Book clearly indicates that the recipient of a scholarship may elect to use the scholarship money for expenses that are not qualified educational expenses, and that this causes the scholarship to become taxable. This option exists if and only if the terms of the scholarship do not require that the money be used exclusively for tuition and other qualified educational expenses. With that being said, this section of The Tax Book notes that most scholarships are unrestricted.

Thus, if the student chooses to use the scholarship money for nonqualified expenses, and reports the scholarship as taxable income on Line 7, then the education credit can be claimed for the qualified expenses that were paid with other money... whether that money came from student loans, savings, gifts, or wherever.

This principle appears to be applicable regardless of whether the student is a dependent of his parents. If the student is not a dependent, then the student reports the scholarship as income, and the student also claims the education credit.

If the student is a dependent, then the student reports the scholarship as income, but the parents claim the education credit.

The Tax Book is not an authoritative source of law. But the opinion of the authors is clear.

This interpretation is also supported by the worksheet found on page 6 of IRS Publication 970. However, it should be noted that Pub. 970 has not yet been updated for the current tax year.

BMK

[Koss]

Pub. 970

The following text is from page 13 of IRS Publication 970:

Do not reduce the qualified education expenses by any scholarship or fellowship reported as income on the student's tax return in the following situations.

(i) The use of the money is restricted to costs of attendance (such as room and board) other than qualified education expenses.

(ii)The use of the money is not restricted and is used to pay education expenses that are not qualified (such as room and board).

Example 1.

Jackie paid $3,000 for tuition and $5,000 for room and board at University X. The university did not require her to pay any fees in addition to her tuition in order to enroll in or attend classes. To help pay these costs, she was awarded a $2,000 scholarship and a $4,000 student loan.

The terms of the scholarship state that it may be used to pay any of Jackie's college expenses. Because she applied it toward her tuition, the scholarship is tax free. Therefore, for purposes of figuring an education credit (either Hope or lifetime learning), she must first use the $2,000 scholarship to reduce her tuition (her only qualified education expense). The student loan is not tax-free educational assistance, so she does not use it to reduce her qualified expenses. Jackie is treated as having paid $1,000 in qualified education expenses ($3,000 tuition – $2,000 scholarship).

Example 2.

The facts are the same as in Example 1, except that Jackie uses the $2,000 scholarship to pay room and board, and, therefore, reports her entire scholarship as income on her tax return. In this case, the scholarship is allocated to expenses other than qualified education expenses. Jackie is treated as paying the entire $3,000 tuition with other funds and can figure her education credit on the entire $3,000.

As I noted above, this publication has not been updated by the IRS to address the new legislation. But I don't think the new legislation has an impact on this particular question.


BMK

[Snaggletooth]

Koss

Burton, as is often the case, you have done a masterful job in explaining this.

I have two observations:

1. You mention if the scholarship/grant is taxable to the student, it is reported on Line 7. This doesn't appeal to my intuition unless the assistance is in the form of a work/study program. If he is actually performing work for a University, such as working in the cafeteria he should receive an outright W-2. Why not line 21?

2. From your explanation and also TTB, a "restricted" scholarship would not be income. If the student never received any money whatsoever but instead had the scholarship directly applied to tuition, then it would be difficult to claim the assistance was "unrestricted" unless the student directed the funds to apply directly in lieu of payment to him.

(If the National Organization of Women is listening, feel free to substitute "her" for "him" to your hearts' content)

[Koss]

Line 7

Snaggletooth wrote:

You mention if the scholarship/grant is taxable to the student, it is reported on Line 7. This doesn't appeal to my intuition unless the assistance is in the form of a work/study program. If he is actually performing work for a University, such as working in the cafeteria he should receive an outright W-2. Why not line 21?

'Cause the IRS wants you to put it on line 7.

See page 21 of the instructions for Form 1040 (2009).

There's a method to the madness. They want it on line 7 because it needs to be there in order for a half-dozen worksheets to function properly. For example, the amount of a taxable scholarship is treated as earned income when calculating the standard deduction. See the worksheet on page 36 of the instructions for Form 1040 (2009).

Your software should be able to do it. When you start entering data for a new Form W-2, there should be a field where you identify the type of W-2. Most of us deal only with standard W-2 forms. But there's usually an option to select, say, foreign earned income for which a W-2 was not issued (which also belongs on line 7). There should also be an option for taxable scholarship income. Either that or your program has a whole separate screen for taxable scholarships and grants...

BMK

[Lion]

Divorced parents

And, don't forget that if Dad pays the tuition but Mom claims the child as a dependent, then MOM gets to claim the education credit even though she did not pay anything. A strange little quirk due to funds paid on behalf of the child being deemed paid by the child, but parent getting credit for payments "made" by her dependent child.

[nwtaxlady]

thanks KOSS! And SCH on Line 7 because...

Snaggletooth wrote:



'Cause the IRS wants you to put it on line 7.

See page 21 of the instructions for Form 1040 (2009).

There's a method to the madness. They want it on line 7 because it needs to be there in order for a half-dozen worksheets to function properly. For example, the amount of a taxable scholarship is treated as earned income when calculating the standard deduction. See the worksheet on page 36 of the instructions for Form 1040 (2009).

Your software should be able to do it. When you start entering data for a new Form W-2, there should be a field where you identify the type of W-2. Most of us deal only with standard W-2 forms. But there's usually an option to select, say, foreign earned income for which a W-2 was not issued (which also belongs on line 7). There should also be an option for taxable scholarship income. Either that or your program has a whole separate screen for taxable scholarships and grants...

BMK

thanks for all the good info. I have seen situations were you put the taxable scholarships on line 7 (as per IRS insructions) it changes the EIC and additional child tax credit! Look at my original question. Taxpayer gets $7,000 in scholarships and only has $3,000 in qualified education. Can you tax all the $7,000 then take an education credit using the $3,000? If you run the number both ways it makes a difference.

Take a single Mom (age 30 and a fulltime student) with 17,000 wages and has Scholarships of $7,000 and has 2 kids. If you tax all 7,000 of Scholarships and take 3,000 education credit (AOC) then her EIC will be lower, Additional child tax credit will be more and I believe a portion of the American Opp. Credit would be refundable. This scenario make a BIG difference in the bottom line refund amount. If you do the common way of reducing the qualified tuition by the scholarships which wipes it out and then has 4,000 of taxable scholarships then her bottom line refund is less.

So it does matter which line taxable scholarships on put on..for that exact reason above.

[Snaggletooth]

Earned Income

Ah yes! Put it on Line 7 because it is "earned income" and increase the EIC! Earned income even though it may be a grant and the student has done nothing to "earn" this income (other than, in general, to maintain good grades).

And go for the extra EIC, why not? No one has mentioned, however, that earned income, except in specified situations, is supposed to be taxable under social security and medicare. Yet, apparently a schedule SE is not required. Does anyone know why? or is this just one of those inconsistencies that we encounter in IRS instructions and code?

[Koss]

Not for EIC

A taxable scholarship is not earned income for purposes of EIC.

The EIC worksheet, found on page 50 of the instructions for Form 1040, determines earned income by starting with Line 7. But the very next sentence directs the reader to subtract any taxable scholarship or fellowship grant.

There are other reasons that a taxable scholarship should nevertheless be included on Line 7, such as the example in my earlier post, involving calculation of the standard deduction. As noted by nwtaxlady, Line 7 also affects the Additional Child Tax Credit.

In some cases, EIC is determined by AGI, and not by earned income, so, yes, it can make a difference. It can actually reduce the amount of EIC.

On a related note: Undergraduate students who work for the school at which they are enrolled are generally exempt from social security and medicare anyway...

BMK