Grants and the AOC

[dan doshan]

Can't resist giving another example. Someone gets 5,000 in scholarships and grants for college. They have 5,000 dollars in various qualified expenses, tuition, books, fees, etc. they also take out 5,000 in student loans. The student does not work or works very little and lives at home while attending college. Now we say well ... we'll just arbritarily assume that the 5,000 in student loans was used to pay for the qualified expenses and the 5,000 in grants was used for other living expenses and report the 5,000 in grants on the students tax return with little or no tax liability. The parents claim the child's exemption and get a 2500 dollar credit. Somehow I don't think that was the intent or the reading of the code and regs.

[dan doshan]

I don't have any problem with the arbritrarily including any amounts of grants in taxable income. I don't think that is an option at all no matter how you read the rules and regs. As I would understand things, you only could allocate amounts if the terms of the scholarship or grant stated that funds were unrestricted and could be used to pay for any school expenses including room and board (then what amount would one use for schools that have no such cost.)

My point is that find a client that can furnish you with such information. Good Luck. I don't think it is my job to research their scholarships and grants. I also don't think State or Pell grants are given for one to use some of the funds to go to Vegas and have a ball.

[FEDUKE404]

Playing the game

....Real Life ... A client comes in with a 1098T that shows 5,000 in qualified expenses and 7,000 in scholarships and grants. What do you do as a taxpreparer? Some just go ahead and apply say 4,000 to taxable income freeing up 2,000 for the AOC. On what grounds do they do this. What client that you have ever had could actually furnish you with any documentation as to what exactly were the terms of any of these scholarships and grant. In the years since the Hope Credit came into existence I have had only 1 single client that could. None of the others had any clue whatsoever no matter how much I may have encouraged or questioned them on this.

Most of us here agree any Form 1098-T is basically a worthless piece of paper.....and that's being kind.

In answer to your point: Since most schools now report "billed" and not "paid" qualifying expenses, then the burden is on the client to provide what was paid when, to include the scholarship issues as different time periods may be involved.

As discussed previously, there is some confusion over how/whether a person can arbitrarily designate grants/scholarships as "taxable" in order to benefit from the AOC.

I will continue to follow this thread in hopes of a definitive answer.

FE

[dan doshan]

I wrote a post in regards to dkss post but must have forgot to submit. Anyway, disregarding that, the NATP stuff has been known information forever. However, in my opinion the answers, examples, etc. are confusing and not particularly clear or applicable to real life situations.

Real Life ... A client comes in with a 1098T that shows 5,000 in qualified expenses and 7,000 in scholarships and grants. What do you do as a taxpreparer? Some just go ahead and apply say 4,000 to taxable income freeing up 2,000 for the AOC. On what grounds do they do this. What client that you have ever had could actually furnish you with any documentation as to what exactly were the terms of any of these scholarships and grant. In the years since the Hope Credit came into existence I have had only 1 single client that could. None of the others had any clue whatsoever no matter how much I may have encouraged or questioned them on this.

[FEDUKE404]

Confusion still reigns

Kudos to dkss for the extensive research. My conclusion is it would take a tax attorney to figure out all of the nooks and crannies there.

However, I still choke a bit on "not" using the Pell Grant (and similar grants if available) to offset the "qualifying expenses" to be used for the AOC.

Are you SURE that is an option? My main confusion is that since, apparently, the Pell Grant is (by definition) deemed to be tax-free, can a recipient "choose" to call it taxable and thus otherwise create some taxable income (but likely untaxed!) resulting in then receiving some IRS money (including refundable credits) due to artificial AOC qualification?

I completely concur there is some wiggle room for how to treat scholarships (taxable/untaxable amounts) but I am not yet convinced that option even exists when a Pell Grant is in place to pay ALL of the qualifying educational expenses as reported on a Form 1098-T. I even made a quick run through Pub 970 and found no definitive answer.

Also, the overall facts of this example still make little sense in relation to money received versus expected education expenses, especially when room/board should be a non-issue for a local community college where the student also has a family. Something just does not pass the smell test - but that is a topic for another discussion.

I did some quick looking around (time is limited) and even found this:

Q: What if expenses are paid with tax-free aid, such as the Pell Grant?
A: If the grant or scholarship is tax-free (as a Pell grant is) you cannot use the portion of expenses paid by that award to figure the credit. If you had expenses beyond the award amount, use that portion for the credit. Other tax-free aid includes scholarships, fellowships, employer provided educational assistance and veteran’s educational assistance.

FE

[dkss]

NATP response

I decided to use my free NATP research question on this issue. Here is their response:

Here is the answer:
If the grants can be applied to anything and she picks it up as income on her return, then the grant does not reduce the qualified education expenses for the AOC. See the information and examples below.

¶A-4543. Scholarship and fellowship grants that reduce qualified tuition and related expenses for purposes of Hope and Lifetime Learning credits.
The amount of qualified tuition and related (QT&R) expenses taken into account in computing the Hope credit (AOC) and the Lifetime Learning credit must be reduced by the amount of any qualified scholarship that's excludable from gross income under Code Sec. 117 . . For purposes of this rule, a qualified scholarship that's excludable from gross income under Code Sec. 117 includes any scholarship or fellowship grant (including a Pell grant 35 ) that is excludable from gross income under that Code section 36

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35
Notice 97-60, Sec. 1, Q&A 20, 1997-2 CB 310 ; Notice 97-60, Sec. 2, Q&A 11, 1997-2 CB 310 .
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36
Joint Comm Staff, Gen Expln of '97 Tax Legis (JCS-23-97), 12/17/97, p.19.
A restricted scholarship that must be used to pay QT&R expenses is a qualified scholarship excludable under Code Sec. 117 37 (thereby reducing the amount of QT&R expenses a taxpayer may otherwise take into account in claiming an education credit). 38

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37
Preamble to TD 9034, 12/24/2002 .
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38
Preamble to Prop Regs, 1/6/1999 .
However, a scholarship or fellowship grant is not treated as a qualified scholarship excludable under Code Sec. 117 to the extent that one of the two following conditions applies: 39
(1) The scholarship or fellowship grant (or any portion) may be applied, by its terms, to expenses other than QT&R expenses within the meaning of Code Sec. 117(b)(2) (such as room and board ) and the student reports the grant (or the appropriate portion thereof) as income on the student's federal income tax return if the student is required to file a return. 40 In other words, to the extent that an unrestricted scholarship, or a portion of the scholarship, is used to pay nonqualified expenses and such use is consistent with the terms of the scholarship, the scholarship is not a qualified scholarship excludable under Code Sec. 117 . 41
Illustration 1: University charges A $3,000 for tuition and $5,000 for room and board. University awards a $2,000 scholarship to A. The terms of the scholarship require that it be used to pay tuition. The scholarship is treated as a qualified scholarship that is excludable from income under Code Sec. 117 . 42
Illustration 2: The facts are the same as in Illustration (1), except that the terms of the scholarship permit it to be used to pay any of a student's costs of attendance at University, including tuition, room and board, and other incidental expenses. University applies the $2,000 scholarship against A's $8,000 total bill. A pays the $6,000 balance of the bill with a combination of savings and amounts she earns from a summer job. University does not require A to pay any additional fees beyond the $3,000 in tuition in order to enroll in or attend classes. A does not report any portion of the scholarship as income on A's federal income tax return. Because A doesn't report the scholarship as income, the scholarship is treated as a qualified scholarship that is excludable from income under Code Sec. 117 . 43
Illustration 3: The facts are the same as in Illustration (1), except that A reports the entire scholarship as income on A's federal income tax return. Since the full amount of the scholarship may be applied to expenses other than qualified expenses (room and board) and A reports the scholarship as income, exception (1) above applies and the scholarship is not treated as a qualified scholarship excludable under Code Sec. 117 . 44

Illustration 4: The facts are the same as in Illustration (1), except that the terms of the scholarship require it to be used to pay tuition or room and board charged by University, and the scholarship amount is $6,000. Under the terms of the scholarship, A may allocate the scholarship between tuition and room and board in any manner. However, because room and board totals $5,000, that is the maximum amount that can be applied under the terms of the scholarship to expenses other than QT&R expenses. Therefore, at least $1,000 of the scholarship must be applied to tuition. As a result, the maximum amount of the scholarship that qualifies under exception (1) above is $5,000; and at least $1,000 must be treated as a qualified scholarship excludable under Code Sec. 117 ($6,000 scholarship - $5,000 room and board). 45
(2) The scholarship or fellowship grant (or any portion) must be applied, by its terms, to expenses other than QT&R expenses within the meaning of Code Sec. 117(b)(2) and the student reports the grant (or the appropriate portion) as income on the student's federal income tax return if the student is required to file a return. 46
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[dan doshan]

This has been going on ever since the Hope Credit first came into being. I gave up some time ago. If they get a 1098T that shows 4000 in qualifying expenses and 6000 in grants abd scholarships, etc. then I can only assume that the qualifying expenses were paid for via grants and scholarships. No manipulating the numbers.

If, on the other hand, a student is awarded a Scholarship from some source and the Scholarship terms are not restricted to certain educational expenses that is another story. In my several years of tax prep I have only had 1 client that had received a large Scholarship, from a source, the terms of which were unrestricted as to how it was used.

If these grants etc. can be manipulated in such a way so as to get clients education credits then I sure have screwed clients out of a lot of money over the years.

[FEDUKE404]

Do some homework on this issue

I finally received a response from the Financial Aid office at the local community college. They stated that the Pell grant and the SEOG were unrestricted and could be used for living and transportation expenses.

So, I will go ahead and make a larger portion of the grants taxable (used for personal expenses). Allocate the loans to pay education expenses and take the refundable portion of the AOC.

I would be very wary of "tax facts" from most financial aid offices. After all, these are the same folks who prepare the Forms 1098-T.

It has been my experience, especially for community colleges and the like, that the Pell Grants are pretty well stopped before any taxable income could in theory be generated, i.e. up to the amount of qualifying education expenses. After that, the loans kick in.

I also got a bit lost as to why a person with $4k of education expenses would be receiving $13k in loans/grants. "Pretty good work, if you can find it." I'm also a bit intrigued as to how she would ever obtain "living expenses" at a (supposedly local) community college???

Although I don't have time to do any research, I seem to recall the question raised by taxmom34 about any grants/scholarships FIRST being applied to qualified education expenses. **IF** that rule (still) applies, then by definition there would be no education credit issues to be considered in the first place.

Tread VERY carefully here. . . . .

FE

[dkss]

Update

I finally received a response from the Financial Aid office at the local community college. They stated that the Pell grant and the SEOG were unrestricted and could be used for living and transportation expenses.

So, I will go ahead and make a larger portion of the grants taxable (used for personal expenses). Allocate the loans to pay education expenses and take the refundable portion of the AOC.

[dkss]

my understanding may be wrong but i thought i read somewhere that college enrollment had to be right after high school, (so a student couldn't go to work for four years and then decide to go to college and get the credit). and isn't the taxable scholarship reported on line 7 with wages. not sure if that income is included for calculation of EIC

The AOC does not have a requirement that it can only be taken immediately after high. It can be used for the first 4 years of college regardless of how long ago you graduated from high school.

Taxable scholarships are reported on line 7 but are backed out in the computation of the EIC.

Currently, I have found out that the state grant is restricted for educational expenses only. I have two messages out to the financial aid office at the college for info concerning the Pell grant and the SEOG. When I called the gov number concerning those two grants, I was referred to the college's financial aid office...now if they would only respond back....

[taxmom34]

my understanding may be wrong but i thought i read somewhere that college enrollment had to be right after high school, (so a student couldn't go to work for four years and then decide to go to college and get the credit). and isn't the taxable scholarship reported on line 7 with wages. not sure if that income is included for calculation of EIC

[dkss]

Yes, she is in her first 4 years of post secondary education pursuing a degree. She has not attended college before now.

As for EIC, I think taxable grants are not considered "earned" income for the purpose of the EIC, although her $400 in wages would be make her eligible for a little EIC.

[taxmom34]

That's the first question -- first 4 years of post-secondary education, etc?

Second question is "Does she meet the special qualifications for the refundable portion of the AOC?"

If she meets those qualifications, and all or part of the grant is not explicitly allocated to qualified educational expenses, I would think you could do what you suggest.

it doesn't sound like you answered the first question. at 30 did she just get out of high school? using the same numbers would she qualify for the EIC instead?

[dkss]

in looking at the numbers on this client's return, you have earned income $400 and taxable grants $2000 or $6000 . she doesn't even have to file if she is claiming herself on the tax return. how old is she? are parents claiming her on their return and taking the education credits.? wouldn't parents benefit more by claiming her? are you including the loans of $7000 as taxable?

She is an adult (30+) single mom with dependent child, does not live with parents or anyone else. She does get food stamps and other welfare benefits and she has another child who receives SS from deceased father. I would not include a loan as taxable income. I understand that she is not required to file a return, I am curious if the grants can be manipulated in a way that the refundable portion of the AOC can be legally claimed. I am still awaiting the response from the financial aid office at the college to check the usage restrictions (if any) on the three different grants.

[taxmom34]

in looking at the numbers on this client's return, you have earned income $400 and taxable grants $2000 or $6000 . she doesn't even have to file if she is claiming herself on the tax return. how old is she? are parents claiming her on their return and taking the education credits.? wouldn't parents benefit more by claiming her? are you including the loans of $7000 as taxable?