Yet Another "Taxable Scholarships" Question

Paying for College
1

I realize these questions come up every year at tax time. This is my first time to post a question on the subject.

This year, I am particularly overwhelmed by the idea that my 21 year old apparently has to pay between $4000 and $5000 on taxable scholarship amounts along with a small underpayment penalty … and possibly even an AMT?! Really? I’m wondering if there’s something I missed or something I did wrong here!

I’m using TurboTax. I’ve tried all different variations with the data – changing my tax forms, changing his tax forms, entering in the income sections, entering in the deductions sections. About the same results no matter what I’ve tried.

I DO understand that he is very, very blessed to have received such significant scholarships … and that our problem is, I guess, a good one to have. But I’m annoyed with it. It seems unfair – especially that he’s having to pay at MY tax rate!

Here are the reasons that we’re in this boat this year far more than the past 3 years …

My employer filed bankruptcy in 2013 and then paid out an Equity Distribution to employees in 2014 – to make up for terminated pension plans, etc. My portion of the Equity Distribution put me in a much higher tax bracket than I’ve ever been. My own taxes are huge this year as a result. I had to guess on the amount of my Distribution, and then I paid what I guessed would be a good amount of Estimated Taxes all last year to make up for it – but I will still owe $5000 more and will have a tiny underpayment penalty for guessing wrong. That’s for my own taxes.

And then my son, who has always received a lot more in scholarships than the full costs of his education, ALSO received a research grant this past summer without any other QEE to offset it. This year, on his 1098-T, his scholarships and grants approached $40,000, and his amounts billed were about $10,000. Sheesh. We are in trouble!

As in all years, he has paid estimated taxes all year long to try to offset his tax bill. But at the time that I set his estimated taxes up, he hadn’t yet received the summer research grant. So, as with my own Equity Distribution, I guessed wrong.

Now, like me, he will have a small underpayment penalty, AND he will owe HUGE bucks on top of the estimated taxes he’s paid all year, mostly because he will have to pay for the taxable portion at MY atypically high tax rate this year! I have to pay AMT … in some variations, he will, too!

On top of that, because my Equity Distribution put me in such a high bracket, neither of us qualifies for any of the credits.

I just can’t believe that my son will have to pay so much for the privilege of earning all those scholarships and grants. It seems wrong. I DO understand that it makes sense to pay SOME taxes on this “free” money. But to pay so much at such a high rate? It just seems wrong.

Is there anything I can do? Anything I’ve overlooked that you can tell? Any suggestions on how to best enter the data to minimize his taxes?

Thanks so much!

2

He only paid $10,000 in tuition, books, fees? For the entire year? If so, it is like he ‘earned’ $30k, so taxes on that as income are probably about $5000, ~18%.

I thought if you withheld at least 90% of what your taxes were in a previous year there was no penalty for under withholding? Does he really meet the requirements for AMI or is he stuck with that because you are stuck with that?

3

Is the research grant included in the $40k on the 1098T? Was it reported to you any other way, a 1099 or W-2?

Were his estimated payments at least as much as the tax he owed for 2013? It’s 90% of the current year amount owed or 100% of the previous year tax owed to avoid the penalty.

4

The research grant IS included in the $40K on the 1098T. He DID get a small W-2 for research, but it was for the school year, not the summer that he was doing research. They didn’t withhold taxes, and because his unearned income counts as “wages” on the 1040, he has to pay a good tax rate on that small amount as well.

Yes, his estimated tax payments were for $1 less than he owed for 2013 – and a $1 less only because I made the actual amount divisible by 4, for 4 even ES1040 payments. But still, Turbo Tax thinks he owes a $12 underpayment penalty. I don’t even care about that, actually, even if it’s wrong, because at this point all of this is just too much work and too overwhelming! I cannot believe he has to pay nearly $5000 in taxes. Big surprise.

Yes, twoinanddone, he goes to a state school and paid only $10,000 in tuition and fees for the entire year. That’s the 1098-T amount in Box 2 – the amount he was billed. I added books and equipment into Turbo Tax later – at about $2000. Didn’t help a whole heck of a lot.

For a bit there, I followed another hopeful rabbit trail … saying that he provided more than half of his own support, which would render him non-dependent, which would get him off my taxes and totally on his own, like his older brother who has similar scholarship amounts and expenses that DIDN’T generate monstrous taxes! Which is true! He DID provide more than half his own support because all books, meals, room and board, EVERYTHING (except, by my choice, auto insurance, iPhone, and then medical) pretty much really did come out of his own pocket, thanks to those giant scholarships. BUT, the catch is, he didn’t provide more than half of his own support on EARNED income. He provided more than half his own support on UNEARNED income – and guess what? He is then my dependent, whether it serves us well or not!

I’m stuck. Any ideas?

5

In my latest Turbo Tax rendition, the one where he is non-dependent (provided more than half his own support, but on unearned income), TurboTax computed no underpayment penalty and he owes just $216 after paying basically the equivalent of his 2013 taxes via Estimated Tax Payments. That is much, much better than $5000-ish. But, again, it’s based on providing his own support through ginormous “unearned income” (scholarship funds), as opposed to “earned income.”

Thoughts? Advice? Throw me a rope!

6

For dependency, scholarships and grants aren’t considered support the student provided themselves. They are considered support provided by a third party.

Page 15 of Pub 501:

http://www.irs.gov/pub/irs-pdf/p501.pdf

7

Right. If I understand what you’re getting at @annoyingdad, you’re saying that he can’t claim that he provided more than half of his own support. Which I realize – it’s the other way of saying that he did NOT provide his own support from EARNED income, right? In other words, he cannot claim that he is non-dependent. He has to be my dependent.

If that’s that what you’re saying, I get that. That’s kind of what I’m beefing about – and trying to work around.

And so, I am back to square one with him paying a $5000+ plus tax bill and ME paying a $5000+ tax bill, and both of us paying a very small underpayment penalty despite paying kind of hefty Estimated Taxes all year, and at least one of us (sometimes both of us) paying AMT.

It just seems crazy that my 21-year old student would have to pay that amount.

It’s like the IRS is having it both ways. He can’t claim that he’s not dependent on me – therefore, he has to pay his taxes on very generous scholarships that he “earned” … but at MY rate. AND, the reality is that he DID provide more than half his own support WITH those generous scholarships. I certainly didn’t take his money from him and use it for my own purposes. Is the IRS thinking that parents are taking their kids’ scholarship money and using it for themselves as “income?”

I liked the old rules better, when taxable scholarships were NOT considered “unearned income” for the Form 8615. I DO understand that the IRS wants to keep parents from sheltering their own assets within their children’s assets, in order to effectively pay taxes at their children’s lower rates. But this really IS my son’s “income” of sorts. Not mine. I certainly had nothing to do with earning it! With the requirement this way, they have my son coming and going. Unfair. Wah. Mad. Disappointed. Hoping for a brilliant, legal solution that I haven’t yet considered.

8

I think I was the last one that started a thread on taxes on scholarship but if you read that thread you’ll see I don’t know anything about taxes so I could still have this all wrong. From what I read scholarships are now considered EARNED income for tax purposes and therefore taxed at the students tax rate, or it that just for the amount up to the amount of the standard deduction? Why do they have to make taxes so flipping complicated!

A. The parent can still claim the student as a dependent if the student doesn’t claim the personal deduction.
B. The student can claim the standard deduction ($6.2K) against taxable scholarship money even if he is claimed by the parent.

http://www.irs.gov/publications/p501/ar02.html#en_US_2014_publink1000220868

Scholarships. A scholarship received by a child who is a student is not taken into account in determining whether the child provided more than half of his or her own support.

Gross income also includes all taxable unemployment compensation and certain scholarship and fellowship grants. Scholarships received by degree candidates and used for tuition, fees, supplies, books, and equipment required for particular courses generally are not included in gross income. For more information about scholarships, see chapter 1 of Publication 970.

Earned income. Earned income includes salaries, wages, professional fees, and other amounts received as pay for work you actually perform. Earned income (only for purposes of filing requirements and the standard deduction) also includes any part of a taxable scholarship. See chapter 1 of Publication 970, Tax Benefits for Education, for more information on taxable and nontaxable scholarships.

9

According to the IRS, scholarships are not taxable under normal circumstances. I assume what you are talking about is paying taxes on the money he received and used for room and board. The IRS also says (at least as I read it) that money paid for research is not taxable unless it is required for keeping a scholarship. It sounded in your original post like that was not the case.

http://www.irs.gov/taxtopics/tc421.html

Edited to add: When my accountant did my kids taxes they only paid at their tax rate (not mine). I’m confused why your son would be any different.

10

I was also pointing it out with regard to your older son based on how you posted his support information. I think the ‘earned’ income part of the support standard is only relevant to being able to avoid filing the 8615.

http://www.irs.gov/pub/irs-pdf/i8615.pdf

Long ago there was a thing called income averaging where you could spread out a blip year like you’ve experienced over several years but now it’s only available to farmers and fisherman.

Actually I think the IRS was trying to be generous to most families in allowing the parents to take the child’s exemption despite having earned scholarships or grants. But the change including scholarships and grants for the kiddie tax has thrown a big wrench into that.

11

Hey, @3scoutsmom. Thanks for chiming in!

I do understand all that you’ve just said. Except for a tidbit in your first para, I agree with all you said and am hoping to legally find a way around all that. It hardly seems justifiable or explicable to me. But I’m about to give up and send in payments upwards of $10,000 for the two of us combined. Ouch.

In your first para, I do think that one thing is wrong – somehow along the way, Turbo Tax morphed my son’s tax return and my own tax return together, in terms of the Form 8615, (???) and said that he had to pay the taxable portion at my rate. I don’t remember how or when in the process that happened, or even why at this time – my head is spinning with all the computations! – but somewhere along the way, it was determined by Turbo Tax that he had to pay at my rate. I think it’s because he’s my dependent and the IRS doesn’t want parents sheltering their own assets within their children’s assets and thereby paying artificially low rates on their own stuff. So, they keep that from happening by making our kids pay taxable portions at OUR rates.

Like you, I’m no expert. I’m just really good at following directions and working my way in, out, and around Turbo Tax. But this year, I’m at a loss.

To somebody who might know, is this not right? He apparently has to pay the taxable portion of his scholarships at my rate, correct?

12

I don’t think so

http://www.irs.gov/instructions/i8615/ch01.html

Here is why I think he can pay at his rate:

13

For tax years 2013 and 2014 the title of form 8615 was changed from the previous Investment Income to Unearned Income and the bolded part below was added to the instructions. It appears this will continue going forward.

Last year at this time the tax software companies were scrambling to generate the 8615 for taxable scholarship and grant amounts over $2000.

The amount exceeding $2000 will be taxed at your rate.

14

@TVcaster, thanks for your input. I’m just guessing, but maybe your kids got to pay their taxes at their own rates because the Form 8615 didn’t get thrown into the picture for them. My younger son meets ALL of the requirements for filing the Form 8615 that @annoyingdad so generously quoted above. He therefore ends up getting taxed at my rate. I’m reeling at the unfairness of it all.

And @annoyingdad, you’re absolutely correct. Thank you so much for clarifying! I now see why my younger son has to pay all that money at that higher rate while my older son, with similar scholarships and similar college expenses, got to pay at his own rate. My older son is a graduate student and ALSO has a EARNED income to report (3 jobs). He provides more than half his own support from his EARNED income. He therefore didn’t meet the “Who Must File” criteria for the Form 8615.

My younger son, an undergrad student, has a mere pittance of an “earned income.” He therefore has to pay his taxes at a much higher rate! So weird!

It hardly seems fair! Which is why I came on here 36 hours into his taxes to fuss up a storm and see if there’s some way out of this. But alas, it appears there’s not. Very disappointed. What a waste of money for my very hard-working undergrad son. He’s throwing a ton of his scholarship money away – well, to the government. Sad for him.

15

@SimpleLife I think for the amount you are looking at paying I would not trust Tubo Tax, I’d hire a tax consultant.

16

Yes, @annoyingdad, that’s what I’ve come to discover over the past 36 hours. I just couldn’t believe my eyes. I’ve been doing my college kids’ taxes for many years now. Each earned big scholarships, and yet it was not this way before – I didn’t get caught up in the ol’ Form 8615 before because the instructions used to specifically exclude “taxable scholarships” from the reportable unearned income amounts. But not this year or last!

And see, @TVcaster, that is why my son and I are in this boat – because if he files his own taxes, as my dependent (which he has to be because scholarship amounts cannot be counted as his own support), Turbo Tax will take him to the Form 8615. And once he’s on that form, he’s gets morphed into paying his taxable scholarships at my rate. And if i were to file him on my own form, voila! Again, he’s taxed at my own rate.

He is STUCK. There’s apparently no way around it. Very unfair to my son, imo. Ain’t no way a 21-year old student with 17-19 hours per semester, plus research, (i.e. no way to have "earned income’) should have to pay taxes at such an atypically high rate. Atypically high for ME, too, because of special circumstances this year, and I’m old!

17

It just changed last year. The IRS completely changed the definition of unearned income. I can’t imagine what they intended to accomplish with this. I am caught in the same boat as you, although not to the difficult extent. I sympathize with your frustration. the taxes we used to pay for our student have doubled or even tripled. This year my kid also has a summer research amount added on(although less than you mentioned). There is definitely nothing fair about it.

18

If you mean report his income on your return, you can’t do that even if it helped in some way. Only interest and dividend income can be reported on a parent’s return and only if that’s the child’s only income and scholarships and grants are unearned income for the 8615 but not interest and dividend income.

The bottom of this link:

http://www.irs.gov/taxtopics/tc553.html

19

Wow. That sucks. Not only because of the taxes but because the different instructions. All the links I posted said the opposite and looked like they were current. Now I see the newest one. What are all these sport scholarship parents going to do when their taxes are due? We hear all the time that many poor athletes need to be paid above and beyond their scholarships because there isn’t even enough money for books etc.

20

@annoyingdad, yeah, I did know that. I’m with you. Nevertheless, I have tried EVERYTHING that TurboTax will let me try. Some of the “solutions” WILL work on TurboTax – like saying that my son provided more than half of his own support. Turbo Tax allows me to say that and still claim huge taxable scholarships without “earned income” – and it will generate a measly $216 tax bill for son that way. But, yes, I know, that is not a legal way to do his taxes. I’ve just been playing around, trying to find some kind of legal loophole.

Yeah, @TVcaster, it really does suck. No fair at all.

(I DO feel a little weird complaining about my son’s plight with all of his big scholarships – but should the government really be collecting such big bucks from college students who can certainly use the money they earned through a lot of really hard work?)

@Debbie7452 – Hi, old friend! Good to hear from you! It makes sense that you’re in the same boat. I’m glad you chimed in to commiserate. It DOES help, believe it or not. Misery loves company – I mean, it actually does help to remember that I’m not alone, that all sorts of parents are realizing this sad truth this year. I’m very, very frustrated with it.

I guess I’ll just finish both of our returns up tonight and plan on sending the IRS about $11,000 of my previously-bankrupt employer’s oh-so-generous Equity Distribution, which was put forward in some laughable attempt to “make me whole” after terminating my 25 year pension. Really pathetic. But I’ll do it, get it behind me, and make every effort to never think about it again! Oh, excuse me. Did that sound bitter?

:wink: