I am a VITA site coordinator for the past 6 years and am not sure if it is appropriate for me to post on this forum, but I am going to take a chance and am looking for a discussion on this topic.
I have always thought that when a student receives a scholarship that is in excess of qualified education expenses (which are tuition, fees, books and equipment), the remainder of the scholarship is taxable even though it may cover other educational expenses such as room and board. Additionally, as there were no out-of-pocket education expenses borne by the student/family, they are not eligible for American Opportunity Credit.
I came across a different way of capturing the scholarship such that one can get the AOC, and this is described in Pub 970 page 14, complete with examples.
If the terms of the scholarship do not restrict its use to meeting all the qualified education expenses first, the taxpayer can choose to report an additional $4000 of the scholarship as taxable income if these are used for other education expenses. (This is assuming the taxpayer is also working, supporting himself/herself and is a student meeting the requirements of AOC. If this isn't the case, the student can show the additional $4000 as taxable income and the student's parent can claim the AOC). This $4000 of taxable is then shown as being used to pay for qualified education expenses out of the student's pocket and thus qualifies for up to $2500 of AOC. The $4000 may incur a 10% or a 15% tax which is $400 or $600, but with $2500 of AOC, the taxpayer is ahead by $1900 or $2100.
Have any of you used this option? Any comments?
