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Allocating Scholarships/grants to claim AOTC

ScottG

My daughter's scholarships/grants exceeded her tuition and she is commuting so she has travel expenses (gas, food, etc) but no actual room and board since she is living at home. If she claims the scholarships/grants as income on her return, can I allocate those funds to "qualify" them for the AOTC even if she did not have an equal amount of actual expenditures? Not trying to bilk the system but I have seen conflicting info about this.

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GeorgeM

Hello ScottG:

Assuming your daughter’s scholarship or fellowship grant may (by its terms) be used for non-qualified expenses, then yes, you may allocate some of those funds for non-qualified expenses thus making those funds part of your daughter’s taxable income. As noted in your post, allocating some funds to taxable income may increase your daughter’s American Opportunity Tax Credit (“AOTC”) which in turn may reduce your daughter’s tax liability.

However, allocating part of the scholarship or grant to non-qualified expenses is not without limitation. In this regard, any amounts allocated to non-qualified expenses cannot exceed the amount of your daughter’s actual non-qualified expenses that are paid in the tax year. In your situation, it appears that some of your daughter’s non-qualified expenses are limited given that your daughter lives at home and thus does not need to pay for room and board. However, transportation is one type of non-qualified expense, and therefore, you could allocate some of the scholarship and grant money to your daughter’s transportation expenses thus making those funds part of your daughter’s taxable income.

IRS Publication 970, Tax Benefits for Education, at pages 14 and 15, has some nice examples of how taxpayers might go about making scholarship and grant money part of a student’s taxable income in order to benefit from the AOTC. However, as noted herein, the amount of the scholarship or fellowship grant that is applied to non-qualified expenses cannot exceed the amount of the student’s actual non-qualified expenses that are paid in the tax year.

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MatthewD

Hi ScottG,

Here is an article in the community which explains the allocation of the scholarship/grants.

https://community.freetaxusa.com/kb/articles/228-how-do-scholarships-and-grants-affect-your-ability-to-claim-an-education-credit?

By allocating the scholarship or grant, you can increase your qualifying out-of-pocket educational expense and increase your education credit.

ScottG

I have read this but it doesn't answer my specific question which is, if I allocate her scholarships and grants to "room and board and other nonqualified education expenses," given that my daughter is living at home (rent free) while attending college, does room and board need to be an ACTUAL expense she pays out of pocket? Or is it more of a "presumed" expense families can use to maximize the credit?

PS — I understand we would need to add the "nonqualified expenses" to her income in order to do this, the question is is it legal to do it this way?

GeorgeM

ScottG

https://community.freetaxusa.com/discussion/comment/7504#Comment_7504

Very helpful, thank you George!