Earned Income and Unearned Scholarship Income

Forum|Forum|4 years ago
January 31, 2022
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My daughter is a freshman in college (2021-22). She is a dependent on my taxes. She is a full-time student. In 2021 she earned less than $7500 that she paid no income taxes on. The college that she attends provided her with a $4000 scholarship for her rooming for the school year ($2000 per semester). My understanding is that the $4000 is considered unearned income and she may have to file a tax return based on that $4000 even though her total income including that amount is less than the $12,550 standard deduction. Is it possible for me to file that $4000 on my taxes using form 8814 or do we still need to file a 1040 and form 8615 for her separately? Any advice that can be provided would be appreciated.

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Hal_Al

Employee

Actually, Scholarship income is a "hybrid". It is unearned income for most purposes, but it is considered earned income (or compensation) for the purposes of calculating a student-dependent's standard deduction.

So, if she had $7500 of wages and $4000 of taxable scholarship, that is less than the $12,550 standard deduction/filing requirement and she doe not have to file a tax return.

For others reading this, form 8814 (filing child's income on parent's return) can not be used when the dependent has wage income or taxable scholarship.

If his only income is from interest and dividends, Alaska PFD or capital gains distributions shown on a 1099-DIV, there is a provision for entering it on your return, using form 8814. Enter at Less common income / Child's income.

RhodyRam87Author

Thank you for the response Hal_Al. Based on this information is there any concern regarding the “Kiddie Tax”, since the $4000 exceeds the $2100 threshold?

Hal_Al

Employee

No, because there are two thresholds. The unearned income ($2100) and the standard deduction (earned income [including taxable scholarship] +$350).

Yep, that's "fuzzy", but that's they way it works.

Hal_Al

Employee

Let's throw another issue on the table. If the college provided her a $4000 scholarship for room, did they also provide scholarship money for tuition and fees?

Normally, tuition paid for by tax free scholarship is not eligible for the tuition credit. But, there is a tax “loop hole” available. 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 school’s billing statement specifically shows the scholarships being applied to tuition or 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.