Scholarship over qualified expenses filing requirement and child's income question

Q. Based on this, I understand that there is no need to enter the education information on our (parents) tax return.  Can you verify this for me? 

A. The simple answer is yes.  Since all expenses were paid by tax free scholarship, there are no expenses left to claim a tuition credit. BUT, see the “loop hole” explanation below. 

Q. Am I correct that she does not need to file a return? 

A. That is correct. See filing requirements below.

Q.  My third related question is regarding the Less Common Income section of our (parents) tax return/ Child's Income. Does that apply to me?

A. No. If her 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 and enter at Less common income / Child's income.  Since your student has taxable scholarship, that option is not available to you.

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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 $6846 in box 5 of the 1098-T and $7500 in box 1. At first glance he/she has $654 of taxable income and nobody can claim the American opportunity credit. But if she reports $4654 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 $288 in expenses for those course materials, paid out of pocket, she would only need to report $4366 of taxable scholarship income, instead of $4654.

Note that $4366 (or $4654) is still not enough to have to file a return. But you want to have her file to document the reporting of taxable scholarship.

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You do not report his/her income on your return. If it has to be reported, at all, it goes on his own return. If your dependent child is under age 19 (or under 24 if a full time student), he or she must file a tax return for 2021 if he had any of the following:

1.          Total income (wages, salaries, taxable scholarship etc.) of more than $12,550 (2021).
2.          Unearned income (interest, dividends, capital gains, unemployment, taxable portion of 529 distribution) of more than $1100.
3.          Unearned income over $350 and gross income of more than $1100
4.          Household employee income (e.g. baby sitting, lawn mowing) over $2300 ($12,550 if under age 18)
5.          Other self employment income over $432, including money on a form 1099-NEC

"My 21 year old is a full time college student and we claim her as a dependent on our taxes.  For 2021, she received a scholarship which was her only income.  On the 1098T, Box 1 is $6,846 and Box 5 is $7,500.  She had book expenses of $288.  This leaves only $366 taxable scholarship.  Based on this, I understand that there is no need to enter the education information on our (parents) tax return.  Can you verify this for me?"  

CORRECT

In the situation you describe in your question:

The student would not need to file with to claim $366 scholarship if this is her only income. 

You could file without putting any of the education information into your TurboTax program. 

"Also, I have read replies stating that my daughter would need to file a tax return (she has never filed before), but the IRS filing requirements for dependents, including Table 2, does not indicate that she is required to file.  The scholarship is considered earned income for the purpose of filing requirements.  Am I correct that she does not need to file a return? "

CORRECT

We usually state that the student would need to claim the income. Whether they need to file is dependent on their TOTAL reportable income. 

Yes, scholarship income is considered Earned Income IN SOME RESPECTS. It is listed on a 1040 line 1. It does NOT count as Unearned Income for filing requirements. It CAN be used to contribute to an IRA. It will not trigger the Kiddie Tax.

"When I click on "More Info" beside the Child's Income, it states that my child would have to file a return because of unearned income which includes taxable scholarships.  This is not how the filing requirement is explained in the IRS Pub. 501 that I mentioned above.   I don't understand this and do not know what to do in this section for our (parents) tax return."

CAREFUL ON THIS ONE:

It could be  that the program is referring to the $366 or there could be more to it.

First, let's be clear that the program may say that the student needs to file and claim the income, but the student may NOT need file. This is because your program does not know what other income the student has, so is just telling you that the student should start a return, claim this as income and enter any other tax info. Whether the student needs to file is not determined by your TurboTax program, it only would be determined by hers; HOWEVER, do pay attention to -

How much income YOUR program says the student needs to claim.

If you are getting an education credit, such as the American Opportunity Tax Credit. 

In the situation you describe above, if you meet the other requirements for an education credit, such as your Adjusted Gross Income, you have the option of having the student claim additional scholarship income if this frees up expenses for the credit. The American Opportunity Tax Credit is the more valuable credit and maxes out with 4,000 expenses, so using more for that credit is silly. The Lifetime Learning Credit has less stringent restrictions to be claimed, maxes out using 10,000 expenses, but is not as valuable as the American Opportunity Tax Credit.

In other words, if having your student claim $4,366 means you get an American Opportunity Tax Credit, your TurboTax program should suggest that. 

In this case, with no other income, your daughter would still be under the Federal Filing Requirement, but you WOULD enter the education information, such as her 1098-T into your program. 

Please look over Pub 970 for very good advice and examples.

@T4Tax