I found the quote below when reading an old thread pinned in financial aid & scholarships
I have recently learned about this “kiddie tax,” and I have a follow up question. If receiving a taxable scholarship will inflate my income, how does this scholarship impact a younger sibling’s FAFSA/CSS and needs-based financial aid?
In other words, if my (pell-grant eligible) oldest child has received aid or an outside scholarship that covers room, board, books, transportation, personal expenses etc, will that mean that my younger children won’t be eligible for financial aid because it will appear as if I make a lot more money than I do?
For context, my older child will be a college freshman next year. Her needs-based aid covers everything but my parental contribution and her personal expenses (for which she was originally expected to do work study). As I understand it, the outside scholarship will be sent directly to the college and the college will give her a check for personal expenses each semester. The remaining money will replace her college grant --there were no loans in the original package. My parent contribution will remain the same.
If I am reading the above quote correctly, my worry is that her needs based aid and her outside scholarship could make any younger children ineligible for as much needs-based aid. Could that aid potentially mean that they will not be pell eligible and thus will not be able to apply for the same scholarships as their older sister? This is all assuming that my salary remains basically the same. Obviously in the next couple of years my salary could increase and the question would be moot. Thanks!
The kiddie tax revision referred to above (which set tax rates based on those for trusts, without regard to parent income), was reversed after an outcry from low income (particularly Gold Star) families.
Now kiddie tax is calculated as before based on parents marginal income tax rate. If you are Pell Grant eligible then that should be fairly low, most likely 12% federal.
The tax is paid through the kid’s tax return, if they make more than the standard deduction. It doesn’t appear on your tax return so it couldn’t affect any siblings (or things like Pell eligibility). And one would hope and expect that colleges understand where this income is coming from and make sure it doesn’t affect the scholarship itself in future years.
The one thing you do need to consider is the potential tax liability, which might be as much as $1000-$2000 dependent on marginal tax rates and the amount of the scholarship which is taxable. However since there’s only one semester this year for a kid starting in fall 2022 it’s likely this won’t be a concern until you are doing taxes for 2023 in early 2024. But your kid does need to do a 2022 tax return next spring for this unearned income. The free version of TurboTax does include reporting for taxable scholarships.
Note that your parental contribution should be allocated to the room and board expenses not to tuition when accounting for the taxes. I’m assuming you aren’t sending that money to the college and letting them disburse it? Choosing what to allocate your own money to will reduce the amount of tax liability and potentially allow for tax credits to be claimed and/or 529 money to be used. But you should look to see whether the college and/or external scholarship imposes limits on how their grants can be used. For example do they pay room and board first before giving money for any other expenses like travel?
Thank you! Your explanation is super helpful and I will try to sort out how the payment works. Maybe it will become clearer when I actually get a bill on July 1st.
The bill should list how credits were applied. For example my D’s scholarship had separate credits allocated to tuition vs room and board. Where you have an excess refunded then it is presumably to pay for other costs like travel, books and additional food. She will need to keep a tally of spending on these sorts of things (easy to do with bank statements) plus receipts if possible so you can determine what is not taxable (particularly books and laptop).
Good summary above. For the tax discussion see IRS pub 970:
You’ll also want to check into how your state treats the unearned income (scholarship used for room, board, and personal expenses) on the student’s tax return.
You don’t get the bill from the college; your student child does. Just like taxable scholarships are not taxable income to you; they are taxable income to the student.
My kid has finally set me up to log onto her account as a proxy so that I will be able to see the bill.
I had no idea that was even possible until this week, and it was making me a little crazy since I know that I have to make a “parent contribution” and I don’t quite trust my kid to remember to tell me when it is due. But now that I have this proxy access, I will at least be able to see and pay the bill directly on time. My kid is definitely bright but really absent-minded, the sort who will walk out the door without her umbrella or coat when it is cold and wet outside (or maybe she just doesn’t believe in outerwear. I’ve never quite figured that out).