Hooray, your kid got a full ride! How do they pay their income taxes?

Parents Forum
1

There is plenty of chatter here warning students that they need to pay taxes on the scholarship money that exceeds tuition and books, but I haven’t found a discussion addressing how students manage to pay their hefty tax bills.

Maybe it is common knowledge here on CC, but in general I don’t think most students or their parents have any idea that a tax return is supposed to be filed on scholarships above qualifying expenses. I believe that in the majority of situations, the “income” is not being reported, but for the purpose of this thread let’s assume that a tax return is being filed.

Say a student has a true full ride and perhaps they work during the summer as well. They could easily have 20-30k in income to report. After the standard deduction they could owe 3-4k in federal and states taxes.

If it is a merit full ride then parents may have the resources to happily pay the tax bill for their child. But what about when it is all financial aid and the parent can’t/won’t help? How do students with no assets, that use all of their income and scholarships toward room, board, travel, and necessary personal expenses pay 3-4k in taxes?

2

My son is in this situation. He was okay his freshman year as he had quite a bit of graduation money. He had to take out a loan his sophomore year in order to help pay his annual student contribution, summer earnings contribution and income taxes on his scholarship money. His summer earnings and job during the school year did not cover his expenses and the taxes due on his scholarship income. He does have one outside scholarship that helps some. It will be even worse this year because he is studying in France for the summer and the fall and will not be working this summer.

Mind you, neither my son nor I are complaining as his opportunities have been amazing. However, unless you are working high paid internships and about 15 hours a week during school, you will not be able to cover everything. My son works about 10 hours a week. That is the max he can work with all his other activities. He is going to graduate with some debt. Unfortunately, I am not in a financial position to be able to pay his taxes for him.

3

Also, we were completely unaware that he would have to pay taxes on some of his scholarship money until I read a post on the CC financial forum.

4

Since the US federal income tax standard deduction + personal exemption is $10,300 for the 2015 tax year, the actual amount of taxable income from a full ride scholarship is likely to be rather small (and the first federal income tax bracket is 10%).

5

@ucbalumnus - Does a full-ride scholarship (tuition, fees, books, housing, meals, etc.) normally make a student independent for taxes? I keep forgetting how that works.

6

I wrote about this more than a decade ago. The situation arose from a murky and misguided change in tax laws. It is what it is, and there are a few pragmatic solutions to reduce the pinch.

1 it will be reported
2 the student should be able to claim an independent status, especially if he works
3 match the expenses to the income in the first year to maximize the exemption. That means over reporting the INCOME part
4 some of the personal money from the COA could be saved
5 taking a small amount of debt to pay the taxes that should be between 500 and 1500
6 Summer income might reduce the full ride
7 start a consulting or tutoring business that allows to deduct travel and … books

Be careful with 1099 income during the summer. The 15.3 percent of FICA applies. Work study income does not have the FICA.

7

IRS definition of being able to claim a kid as a dependent:

http://www.irs.gov/Help-&-Resources/Tools-&-FAQs/FAQs-for-Individuals/Frequently-Asked-Tax-Questions-&-Answers/Filing-Requirements,-Status,-Dependents,-Exemptions/Dependents-&-Exemptions/Dependents-&-Exemptions-2

8

The solution is to abandon the dependent status to maximize the exemption. A full rider can demonstrate the responsibility of 50 percent.

9

When my daughter was in this situation, I kept her as a dependent on my taxes and took the college deduction on my taxes and paid her taxes with the refund I got. I had to juggle tax filings since I did hers as well as my own but I would do mine first, wait for the refund, then do hers and pay it. Then she got a job and I had her have an extra $100 a month deducted for federal taxes and I continued to pay her state taxes, which were large. (Unfortunately in addition to federal taxes, you have to file state taxes in the state of your residence as well as the state where income is earned if your child is working at school. Luckily for me, only one of those states taxes scholarship income (California).) She was on full scholarship but remember only the living expenses of that are taxable. The most she owed for federal was about $1,200 which is where I came up with the $100 withholding. Since her job was in another state she could not deduct California withholdings so I continued paying that until she graduated, one year I used her federal tax refund to pay her state taxes. With some planning ahead you can make it work.

10

From what I have read scholarships cannot be used to figure the amount of paying more than 50 % of student’s own support. I doubt a fulltime student who works in summers and parttime during the school year can afford to pay most of their own expenses, especially health insurance.

I don’t think it is well known that these scholarships can be taxable. Especially if the student doesn’t work they might not know they are supposed to file a tax return.

Now if the full ride covers just tuition and room and board, then the taxable part will be around $10,000 at most schools. Depending on work income then maybe $7,000 would be taxed. If student’s parents are low income (since those students might have a harder time coming up with the money for taxes) it probably will be taxed at 10%. So the student could work in the summer and save that money, also figuring in the possible state tax.

I do think the student’s family should plan for this because if the tax bill is not paid when the return is filed it can really hold up the FAFSA process for the next school year.

11

nm

12

Also keep in mind, that if the parents’ tax rate is higher than the student’s rate, the scholarship income reported will be subject to “kiddie” tax and will be taxed at the parents’ higher rate. This is a fairly recent change with the IRS several years ago when changed the title of form 8615 from “Tax for certain children who have investment income” to “Tax for certain children who have unearned income” The IRS added taxable scholarship income to the list of what constitutes unearned income.

Be prepared for a tax whammy if your income tax rate is higher than your child’s rate. One of my daughters has a full-ride scholarship and a part-time job and had to pay an additional $1500 in taxes above and beyond her own taxes due to the “kiddie” taxes. Be sure to plan ahead so you do not have an unpleasant surprise come April 15th.

Some states also consider students to be residents of the state where their college is located and the student must file in that state as well as their “home” state and may have to pay state taxes in both states (usually the home state will give the student a credit for taxes paid in the state the income was earned) as well. My daughter had to pay an additional $580 in state taxes as well.

Unless the student also has significant “earned” income from wages and is truly providing their own support, they cannot be considered as independent. Scholarship income cannot be considered as providing their own support. Review Publication 501 for more details. From IRS Form 8615 instructions:

“Support.
Your child’s support includes all amounts spent
to provide the child with food, lodging, clothing, education,
medical and dental care, recreation, transportation, and
similar necessities. To figure your child’s support, count
support provided by you, your child, and others. However,
a scholarship received by your child is not considered
support if your child is a full-time student. For details, see
Pub. 501, Exemptions, Standard Deduction, and Filing
Information.”

Of course, we realize that this is a good problem to have in the end and our daughter is getting a fabulous education which is still an incredible bargain.

This link provides info/instructions for IRS Form 8615
http://www.irs.gov/pub/irs-pdf/i8615.pdf

There are also a number of helpful threads here on CC, but be cautious and read through threads carefully because there is some confusion about “kiddie” tax and independent status, especially the “kiddie” tax because it is a recent IRS change.

13

Some full ride scholarships cover more than tuition and housing, some give stipends that can be used for study abroad or research or unpaid internships, some pay for books, transportation, health insurance, computer.
That will all have to be included as taxable income, whatever exceeds tuition, required fees and books.

Also for a full ride scholarship family to be able to claim education tax credit the student would have to include the amount of expenses claimed in the taxable scholarship income also, basically making some of the untaxable amount of scholarship (the amount that covers tuition for example) taxable.

Also you can’t just choose how much to report for each year, you have to go by when the grants or scholarships have been applied to the student account.

14

A full ride also means that the parents have zero or limited efc contributions. The scholarship is a benefit to the student and HE pays for his room and board. Even if you were to consider the scholarship neutral, every bit of income tilts the balance to an independent status.

15

Not if you read above, it is clearly spelled out.

And merit scholarships can be full rides, doesn’t mean that efc is low, those are not need based.

So you might have a low income kid getting a lower tax rate for kiddie tax because parents are low income. But it might still be hard to pay for the tax unless planned for and work income from summer saved for this.
Or you have a kid getting a much higher tax rate because parents are high income, and although it should be easier for them to pay for the tax that might not be necessarily true because the tax bill could be substantial especially in states who also tax.

16

No first-hand experience in regard to a child’s scholarship (more’s the pity), but the test for claiming a person as a dependent and, therefore, being entitled to claim a personal exemption is “support.” The person who furnishes > 1/2 of the individual’s support is entitled to claim that person as a dependent:

http://apps.irs.gov/app/vita/content/globalmedia/teacher/worksheet_for_determining_support_4012.pdf

Typically these disputes come up between custodial and non-custodial parents, but it’s the same test.

If part of a scholarship is taxable INCOME because it covers non-qualified expenses, then it absolutely can count as part a student’s “support.” It just isn’t “earned income” unless it’s treated as such by the paying institution.

If student provides > 1/2 of his/her own support → student gets to claim his own exemption but parents cannot. Then the standard deduction and personal exemption (not to mention the AOTC) all are his to use.

17

I am not sure I understand or follow the distinction. Let’s assume that the full ride is indeed a complete one and that it includes tuition, room and board, and all other COA costs. This scholarship could be need or merit based, but it would make no differences as the student’s sch9larships insulates parents from making contributions.

If the scholarship is for tuition only, there are no taxes since the QEE reduce the taxable income to zero. So, let’s go back to the pragmatic issues.

If a parent is determined to maintain the exclusion and deduction on the parental side, he will make sure to cover more than 50 percent of the personal costs of the students. This could be done via allocating the cost of staying at HOME during the summer and feeding the kid. The 8-9 months stay in college does not change that part.

However, if the parent decides it is best for the child to report the income (as it is in many zero EFC cases) the test flips the other way, and the student should have no problem defending a position that he (or she) was responsible for its entire year of subsistence. He can do that by claiming the income (he has to) of the scholarship above QEE and showing that part of the COA went for personal expenses. That works, but in case, one takes a more aggressive position, all that is needed is for the student to earn more than his parents provided during the year. This can be done via a work study, an outside job, or a summer job.

All in all, it should be not be hard to espouse the condition that is more beneficial to the student and reduce the taxes to a minimum. Despite the claims to the contrary, it is hard to ignore the taxes if a student receives financial aid as filing the taxes is a requirement for continuing aid.

I reported scholarship income as an independent student for 7 years and the taxes were minimal but real. For students on a need based scholarship, the best option is to borrow the amount needed to pay taxes from a source that defers the interest for the duration of the education and pay it off after gaining full employment. Trying to earn the money can trigger negative effects on the FAFSA for the subsequent years as the student EFC might rise.

18

Xiggi is right about being careful with a 1099-Misc.

My son got slammed with taxes this year. Between his MIT scholarship (need-based aid) that goes above tuition, his corporate yearly National Merit Scholarship, and his 4 jobs, three of which did not take out taxes-and his highest paying job was the dreaded 1099 Misc-he made around 21-22K. Guess what? He owed close to $4000 in taxes between federal and state. Did he have that? Nope. Guess who paid with their refund?

So this year, the IRS is making him pay quarterly which is really hard because his income will all come during the summer. He was able to save enough to pay his April bill. He negotiated with roommates not to pay his June rent so he’ll have money to make his June IRS payment. He’ll then double up rent for July and August, but by then, he’ll have enough to pay his September IRS bill, and will save in order to pay his January bill.

It was also explained that the reason the taxes seem so high on a 1099-Misc is because the IRS is also taking out Social Security (not that he’ll ever see a dime of that, but that’s for another thread).

It was a big lesson for our son to learn, but fortunately, this year was the one year that we had a big return. We normally would not have the money to pay. He’s not frivolous in his spending, but he didn’t budget for 4K in taxes.

19

^^
Sbjdorlo, the situation you describe is not unique.

The reason I mentioned “setting up a business” was exactly for that reason. In the latter years, I regularly deferred income to my final year of education. It helped to report the income as business income as I could use legitimate business expenses to cover equipment, books, fees, travel and telephone. This is easy to do for anyone who works in technology. In so many words, create your own startup or form a partnership with your … parents!

The differences were not huge in terms of taxes but at that time every dollar saved came in handy. I also learned to negotiate an addition 7 percent on the jobs to cover the unpaid SS. In a couple of years, the FICA was lower because of stimulus plans.

20

I don’t get it. Is someone actually claiming that a kid is better off with a LESS generous scholarship?