I would appreciate guidance on this tax issue. My daughter has a tuition but not fees waiver. She has a scholarship that covers some, but not all, of fees, room and board. Does the IRS have rules as to how the scholarship must be allocated?
In other words, if IRS rules are such that the scholarship must be allocated towards fees before room and board, there is no American opportunity tax credit possible except for books. If there is no such rule then I assume I can allocate the scholarship towards room and board and claim the tax credit for fees?
Thank you.
The IRS doesn’t have rules on how things must be allocated. But if the terms of a grant/scholarship require it be used for a certain purpose then that’s how you must allocate it. Few have that kind of requirement.
The details are in IRS Pub 970, chapter 2. With your daughter having large scholarships you also need to check chapter 1 on taxable scholarships and grants and chapter 2 on coordinating AOTC expenses with expenses used to make scholarships/grants tax-free. So if you allocate her scholarships toward room and board, then she will have to include that amount in her income because QEE for making scholarships/grants tax free is only tuition, mandatory fees and required books and expenses.
http://www.irs.gov/pub/irs-pdf/p970.pdf
Thank you for your reply. I’m glad there are no IRS rules for allocation; the scholarship has none.
Yes, I do understand that I am shifting income to her but gaining a tax credit seems like a good trade. For others in the same situation and to your point, PUB 970 says: “If Bill excludes the scholarship from income, he will be deemed (for purposes of figuring his education credit) to have applied the scholarship to pay his tuition, required fees, and course materials.”
Also, new as of tax year 2013, taxable scholarships/grants are unearned income for the purpose of the kiddie tax, form 8615. They are still earned income for the purposes of filing requirements and the standard deduction. So depending on the numbers, part of your daughter’s income could be taxed at the parent rate. But it may also be true that by doing this your daughter still wouldn’t have enough income to be required to file a return or owe tax even if she files to get some withholding back. But it’s something to look into if you weren’t aware of it.
http://www.irs.gov/pub/irs-pdf/i8615.pdf
Yikes, I was not aware of that until this morning when my tax software (HR Block) brought up the issue. It seems though that TurboTax still treats it as earned income and at least one CPA agrees: https://ttlc.intuit.com/questions/2226503-turbotax-does-not-include-scholarship-income-as-unearned-income-on-form-8615-why-instructions-for-8615-say-it-is-unearned-income
Your link says it’s at least a year old. It took the software companies into February last year to get their software changed. Most tax questions are dealt with on the finaid forum and there was a big thread there last year concerning this. The consensus was that just as there are different QEEs for the AOTC and 529 distributions for example, there can be different definitions of earned and unearned income in different parts of the tax code. This was new last year and that CPA has likely changed his/her mind. All the software that I know of, including TurboTax, now includes the 8615 when required by responses to the education questions and I presume they have some heavy-hitting tax experts that weighed in before that change was made to the software. The 8615 instructions are quite clear.
Thanks for the clear input; much appreciated!
I’m still trying to wrap my head around this. The Kiddie Tax was designed to prevent parents from shifting their investment income to their children. A scholarship (in this case merit) is given to the student. How does the parental tax rate possibly apply? I understand that if the IRS says it does, it does but yet one would think Congress would act to fix this issue.
It was also the consensus of the thread that taxable scholarships have nothing to do with the original purpose of the kiddie tax. I don’t know why it changed for 2013, if it was just an IRS interpretation or if there was a change in law that drove it. In the grand scheme of things, among the millions of students attending all sorts of schools from CC to the elites, scholarships/grants large enough for this to be a factor are quite rare and I’m not sure there will be a ground swell to change it.
I see, thanks. In my case it is significant since she has a tuition waiver. No matter how I allocate the scholarship, the the bulk of her scholarship will be towards room and board and thus taxable apparently at my tax rate.
I must be misunderstanding something else; I hope. The interview process for 8615 asks for the income of siblings who are dependent college students too. Then based on that income my daughter’s tax is increased further. Am I missing something?
Only the amount that is $2k over her standard deduction should be taxable at your rate I believe, though I don’t remember all the details of the calculation.
Line 7 of the 8615 asks for the amount from line 5 of any sibling 8615s. Does your daughter have siblings who also have to file a 8615? The interview questions are probably just trying to determine if an amount needs to go on line 7 of her 8615.
http://www.irs.gov/pub/irs-pdf/f8615.pdf
With all software you should look at the form lines to see what the program has put there in response to your answers to the questions.
Thank you. Yes, my son has taxable scholarship funds too.
I calculated her taxes with and without his income. Her taxes go up with his income added. That makes no sense to me. .