Full ride scholarship - Tax planning

Forum|Forum|5 years ago
July 13, 2020
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I am in the process of completing my 2019 taxes and thinking about planning for future years.

My daughter will be starting college in the Fall of 2021 (more than a year away). She will very likely qualify for a full ride scholarship that will include tuition/fees along with room and board. It's likely she'll be awarded additional scholarships (although I'll ignore this for my calculations below).

My understanding is that the tuition/fees part of the scholarship will not be taxable income. But the scholarships that pay for room and board, travel, etc will be taxable. Room and board at this university is valued at around $10,000.

Most of what I see on the internet is discussions of making sure that your college student doesn't provide 50% of their support so they can remain their parents dependent. However, in this situation it seems to me it would be better if we can arrange it so we can't claim my daughter as a dependent. Am I missing something? My understanding is outlined below.

As a dependent, we (her parents) would have to include the value of the scholarship used for room and board as income and thus be taxed at our rate of 22%. We would not be eligible for any of the tax credits (since all her tuition/fee would be paid by scholarships). We would lose the $500 tax credit for a dependent. That would cost us $1700 (($10,000 * 22%) - $500).

If she wasn't a dependent, the standard deduction would cover the $10,000 scholarship and any additional income would be taxed at 12%.

If I am correct in my thinking, any tips of having her provide more than 50% of her own support.

Thanks,

Not A Product Question

Hal_Al

Employee

Scholarships are third party support and not considered as support provided by the student herself. So, she will continue to be your dependent.

Taxable scholarship goes on the student's return, not the parent's. Taxable scholarship is considered earned income for purposes of calculating a dependent's standard deduction. So, the first $12,200 will not be taxed (unless she has other income). However, scholarship is considered unearned income for purposes of the "kiddie tax" (child's income taxed at parent's rate). The kiddie tax would kick in at $14,400.

There's even a loop hole available that allows you to claim a tuition credit (up to $2500). See below for details.

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There is a tax “loophole” available. The student reports all his scholarship, up to the amount needed to claim the American opportunity credit, 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.