Kiddie tax and taxable scholarships

Financial Aid & Scholarships
#1

I was very surprised to read this article in the Wall St Journal which appears to have misunderstood the implications of kiddie tax on scholarships (https://www.wsj.com/articles/the-surprising-tax-bill-for-sons-and-daughters-of-gold-star-families-11557480602). Though most of the article is about survivor benefits for minors (which may well be a concern) the statements about college scholarships tend to mislead, because in reality you still get the $12K personal deduction on taxable scholarships. So any hit will usually be quite small when room and board costs are typically not much over $12K. Even more alarming, the recommendation appears to be to simply not report this income and rely on the IRS not “enforcing” these rules:

“The Kiddie Tax revision also threatens college students from lower-income families who receive financial aid for expenses other than tuition and supplies. By law such income is taxable, says Tim Steffen, a tax specialist with Robert W. Baird & Co.
If a family is in a low tax bracket, then a child receiving taxable aid could wind up in a much higher bracket—with no money to pay the tax. Mark Kantrowitz, the publisher of Savingforcollege.com, estimates that more than three million students could be affected.
The Kiddie Tax revision isn’t yet a disaster for some of these students for two reasons. Colleges aren’t currently required to report taxable aid to the Internal Revenue Service, and many don’t. Also, the IRS doesn’t seem to be enforcing the law in this area, tax specialists say.
Still, the law is on the books. Financial-aid providers are alarmed and are pushing to make scholarships tax-free.
Robert Ballard heads Scholarship America, a nonprofit that distributed $264 million to 104,000 students last year. He says, ‘College scholarships are to help students get higher education, but the 2017 Kiddie Tax change is pulling in the opposite direction.’”

#2

While the $12k standard deduction is a lot better than the previous ~$6400, it’s not perfect. My daughter paid on amounts over $12k for two of her 4 years when she added her regular summer job income. Her room and board was (way over charged) $13,500 for her freshman year (2014). Schools have a monopoly on R&B and charge whatever they want. R&B at the Boston and NYC schools is often over $17k.

Also seem to be making more during internships. Stanford, for example, charged $16.5k for room and board and $5,200 for its insurance plan. Say this low income student is a football player. That student would get full COA plus either a Pell grant (if qualified) or a stipend, which is about $5000. This student would owe taxes on the $16.5 r&b, any fees that aren’t qualified, the insurance premium, and the stipend - about $26k.

Because the trust & estates brackets are used, the low income student could easily jump to the 24% rate on at least part of the income.

I think the author is correct that many students do not pay the taxes on their scholarships and the IRS doesn’t come after them.

#3

The standard deduction is $12k only if the tax filer is not being claimed as a dependent on someone else’s taxes. Most students are still being claimed as dependents, in which case their standard deduction is the greater of $1,050, or the individual’s earned income for the year plus $350 (maxed at $12,000).

But let’s say the student is NOT being claimed as a dependent and is therefore automatically entitled to the $12k SD.

Room, board, fees, and personal expenses (all part of COA) at Yale, for example, will amount to about $18,000. If the student has no other taxable income, deduct the standard deduction* to get $6k. Then subtract the first $2100 of unearned income (not subject to tax), and total income subject to kiddie tax is $3,900. That amount is taxed at 24%. So the low-income student who is on full financial aid has to come up with $936.

I’m not sure how the standard deduction is applied when the student has both earned and unearned income. If the student above had an additional $6k in earned income, is the standard deduction applied proportionately between the earned and unearned to come up with the amount subject to kiddie tax (in this case 24%) and the amount subject to tax on earnings (in this case 10%)? I don’t know.

*The taxable portion of scholarship funds (the amount in excess of tuition, books, and required fees) is considered UNEARNED income for the purpose of the tax rate—but is considered EARNED income for the purpose of calculating the standard deduction.

#4

For tax year 2019, the first $2,600 of taxable income using the estates and trusts brackets and rates (as the kiddie tax now does) is taxed at 10%. Amounts from $2,600 to $9,300 are taxed at 24%.

For a single student who can be claimed as a dependent on someone else’s tax return, the standard deduction is the greater of either earned income plus $350 or $1,050, up to a maximum of $12,000.

#5

Please correct me if I’m wrong, but I believe there is no benefit anymore at all to claiming your adult or teenage children on your tax return anymore. The personal exemptions are gone.

#6

What about the tuition adjustment toincome? Does the student have to be a dependent?

Also: If your dependent has medical expenses that greatly exceed 10% of AGI. Or other deductions from income.

#7

There is the AOTC as a benefit, and they have to be a dependent for you to claim it.

There is also a $500 tax credit for a dependent child/relative. It is not a refundable credit so only helps if you have at least $500 in tax liability.

Having a college student who is still a dependent can also qualify you as head of household; I’m losing that designation next year as my last one graduated this year. That drops my standard deduction to $12k from $18k.

#8

“Also: If your dependent has medical expenses that greatly exceed 10% of AGI. Or other deductions from income.”

I think you can count medical expenses (like you can cover them on your health insurance and deduct those costs if you are self-employed) paid for your child up to the age of 26 even if they are no longer a dependent.

#9

There is the AOTC as a benefit, and they have to be a dependent for you to claim it.<<<<<<<<<<<

They can claim their own AOTC as they are not dependents though.

#10

@Twoin18 Even if they are not on your health insurance? That doesn’t seem possible.

#11

@brantly The rules are more specific for an individual, you can claim for “Any person you could have claimed as a dependent on your return except that person received $4,150 or more of gross income or filed a joint return.” See https://www.irs.gov/instructions/i1040sca

So if you provide more than half of your child’s support, it appears you can claim medical expenses for them, regardless of their income or whether they lived with you. If they don’t live with you then they are a qualifying relative not a qualifying child.

@Sybylla “They can claim their own AOTC as they are not dependents though.”

But not the refundable part if they don’t provide more than half of their own suppprt. Note there is the situation where a child has moved out permanently (e.g. has moved to another state and is paying taxes as a resident there) but you still provide the majority of their support. In those circumstances they wouldn’t be a dependent if earnings (including from a taxable scholarship) are high enough but they still wouldn’t receive benefits like the refundable AOTC (since the scholarship doesn’t count as support). That’s our situation at the moment, but the benefits of not paying CA taxes (including kiddie taxes at the parents rate) on a scholarship should balance the loss of the dependent tax credit.

#12

The student gets the full 12k deduction. The scholarship is lumped with earned income for this calculation only. See irs Pub 929 page 8 Worksheet 1 footnote:
*Earned income includes wages, salaries, tips, professional fees, and other compensation received for personal services you performed. It also includes any amount received as a scholarship that you must include in income.

#13

@alooknac
The taxable portion of scholarship funds (the amount in excess of tuition, books, and required fees) is considered EARNED income for the purpose of calculating the standard deduction, but is considered UNEARNED income for the purpose of the tax rate.

#14

@brantly
Upthread you said “The standard deduction is $12k only if the tax filer is not being claimed as a dependent on someone else’s taxes” and that is incorrect. The Worksheet with the footnote is specifically for dependents.

#15

No, it’s not incorrect, and it depends on the context. Someone who can be claimed as a dependent on someone else’s tax return may have $12,000 in unearned income (say, a combination of interest, dividends and capital gains distributions), and this taxpayer would only be eligible for a standard deduction of $1,050 and the balance ($10,950) would be taxed. A taxpayer is a similar situation who cannot be claimed as a dependent on someone else’s tax return would enjoy the full standard deduction of $12,000 and would have no income subject to tax.

#16

Well I advise everyone to do their own due diligence.

#17

Just did my kids taxes and crazy state and federal tax on income from scholarships… double taxation. 12000 deductible and books cost deducted (2500 max)

#18

@alooknac Standard deduction for a dependent CAN be $12k, but it is not AUTOMATICALLY $12k.

This is verbatim from the IRS:

IRS Publication 501 (2018)
https://www.irs.gov/publications/p501
Scroll aaaallll the way down to the heading
Standard Deduction for Dependents

IRS Worksheet for Standard Deduction for Dependents
https://www.irs.gov/publications/p501#en_US_2018_publink100022921
Scroll to Table 8: Standard Deduction Worksheet for Dependents

#19

I just went back and looked at my daughters tax return that I did with turbo tax. We claim her as a dependent, and sure enough her standard deduction was her earned income + 350 as has been reported above.

Learned something new, I did not realize they didn’t get the whole 12k deduction.

#20

They do get the whole $12k if they have $12k in earned income. When calculating the earned income, any scholarship amount that is QEE counts as earned income. Other unearned income (dividends, income) is not considered when figuring the standard deduction.

When it is time to pay the tax on those scholarships, they magically return to unearned (kiddie taxable) income.