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The Kiddie Tax is an alternate, higher rate of calculating tax due that applies to young people. While it was intended to ensure that wealthy parents paid their full share of tax on their investments, it also sometimes applies to graduate students whose income comes primarily from a fellowship or training grant.
If you have found this article through search, it’s likely that your (software or human) tax preparer has determined that you owe the Kiddie Tax. This article will help you understand what the Kiddie Tax is, who it applies to, how it is calculated, and how to avoid it in the future.
What is the Kiddie Tax?
Back in the early 1980s, finding tax shelters (i.e., legal ways to avoid paying tax) was all the rage because tax rates were much higher than they are today. The top marginal tax rate was reduced to 50% in 1981 and finally to 28% in 1988 with the last major tax reform prior to the Tax Cuts and Jobs Act (source).
One of the tax shelters was for parents to put income-generating assets in their minor children’s names. The children were (presumably) in much lower tax brackets for investment income than their parents, so overall the family paid less in tax for those assets (source).
In 1986, the “Kiddie Tax” was enacted to close this loophole. Under the Kiddie Tax, a child or young adult’s unearned income is taxed at a higher rate than it would be if they were older (with all other factors being the same).
How Does the Kiddie Tax Affect PhD Students?
The way the Kiddie Tax is written and structured makes sense for the purpose of preventing wealthy parents from sheltering their income using their children. However, it has an off-label effect on PhD students.
The Kiddie Tax applies to all children through age 17, some children through age 18, and some students through age 23. It applies to “unearned income,” which includes not only investment income but also income from fellowships, scholarships, and training grants.
This means that a graduate student under the age of 23 whose income is from a fellowship may be taxed not at the ordinary income rates that they will be at age 24+ but rather at their parents’ marginal tax rate (if it is higher than their own).
(The Tax Cuts and Jobs Act, passed at the end of 2017, changed the alternate tax rate to be the one used for estates and trusts rather than the parents’ marginal tax rate, which it had been historically. This negatively affected college students from low-income backgrounds, who are often funded by scholarships and grants. At the end of 2019, the Kiddie Tax rate was changed back to the marginal tax rate of the parents, which was also retroactively applied for 2018. If you paid the Kiddie Tax in 2018, an amended return may be warranted.)
The PhD students most in danger of the Kiddie Tax applying to them in a way that will massively increase their tax due are those who received fellowship (awarded) income for an entire calendar year, e.g., January of the first year through December of the second year.
Who Has to Pay the Kiddie Tax?
The Kiddie Tax does not apply to every graduate student on fellowship, though it applies to many.
The instructions for Form 8615 lay out who has to file the form and (potentially) pay the Kiddie Tax. There are five qualifications for being subject to the Kiddie Tax, all of which must apply. If any one of the following is not true for you, you aren’t subject to the Kiddie tax.
1) You had more than $2,200 of unearned income.
Taxable fellowship and scholarship income counts as “unearned income.”
The definition of “unearned income” from p. 1 of the instructions for Form 8615 is:
For Form 8615, “unearned income” includes all taxable income other than earned income. Unearned income includes taxable interest, ordinary dividends, capital gains (including capital gain distributions), rents, royalties, etc. It also includes taxable social security benefits, pension and annuity income, taxable scholarship and fellowship grants not reported on Form W-2, unemployment compensation, alimony, and income (other than earned income) received as the beneficiary of a trust.
2) You are required to file a tax return.
The Form 1040 instructions (p. 8-11) answer the question of who has to file a return for 2019.
Chart A (p. 9) is for most people under age 65. It states that you must file a return if you are single and your gross income is at least $12,200.
Chart B (p. 10) is for dependents. You are required to file a tax return if you are single and:
Your unearned income was over $1,100.
Your earned income was over $12,200.
Your gross income was more than the larger of
Your earned income (up to $11,850) plus $350
For the purpose of Chart B only, taxable scholarships and fellowships are “earned income” while “unearned income” includes taxable interest, ordinary dividends, and capital gains distributions.
If your gross income was less than $11,850 and your unearned income (taxable interest, ordinary dividends, and capital gains distributions) was less than $350, you do not need to file a tax return and are not subject to the Kiddie Tax.
Alternatively, you can use the IRS’s Interactive Tax Assistant to determine whether you are required to file a return: Do I Need to File a Tax Return?
3) You are a student under age 24
To be subject to the Kiddie Tax, you must be (Form 8615 p. 1):
Under age 18 at the end of 2019,
Age 18 at the end of 2019 and didn’t have earned income that was more than half of your support, or
A full-time student at least age 19 and under age 24 at the end of 2019 and didn’t have earned income that was more than half of your support.
Full-Time Student Status
Form 8615 refers to Publication 501 for the definition of ‘full-time student’ (p. 12):
To qualify as a student, your child must be, during some part of each of any 5 calendar months of the year:
- A full-time student at a school that has a regular teaching staff, course of study, and a regularly enrolled student body at the school, or
- A student taking a full-time, on-farm training course given by a school described in (1), or by a state, county, or local government agency.
The 5 calendar months don’t have to be consecutive.
Full-time student. A full-time student is a student who is enrolled for the number of hours or courses the school considers to be full-time attendance.
You do not have to be a student throughout the calendar year to be defined as a student and subject to the Kiddie Tax. You are considered a student if you are a full-time student in (part of) 5 calendar months, which do not have to be consecutive.
Defining support and who/what provided it is the trickiest part of determining whether you are subject to the Kiddie Tax. First, you must determine your support, and then calculate whether your earned income amounted to more than half of your support.
The Form 8615 instructions defines support as (p. 1):
Support. Your support includes all amounts spent to provide you with food, lodging, clothing, education, medical and dental care, recreation, transportation, and similar necessities. To figure your support, count support provided by you, your parents, and others. However, a scholarship you received isn’t considered support if you’re a full-time student. For details, see Pub. 501, Dependents, Standard Deduction, and Filing Information.
Publication 501 includes the Worksheet for Determining Support (p. 15), which you must go through in detail. Your support is the amount of money that is used to pay all your living, education, medical, and travel expenses. The education expenses include the tuition, fees, etc. for your graduate degree.
If you do not have earned income totaling at least half of your own support, you may be subject to the Kiddie Tax. Scholarships and fellowships do not count as earned income for this purpose.
The support test being calculated this way creates a very high bar for funded graduate students as tuition can easily rival or exceed living expenses.
4) At least one of your parents was alive at the end of the year
If your parents (including adoptive and step-parents) are deceased, the Kiddie Tax does not apply to you.
5) You don’t file a joint return
If you are single, the Kiddie Tax may apply to you. If you are married filing jointly, the Kiddie Tax does not apply to you.
If you meet all five of these criteria, you need to fill out Form 8615, as the Kiddie Tax may apply to you.
How Is the Kiddie Tax Calculated?
Form 8615 calculates your Kiddie Tax. Part I calculates your net unearned income, and Part II calculates your tax.
You should carefully fill out each line and read the instructions to find the correct definitions. I have highlighted some points about each line specific to fellowship recipients, but you still need to read the full instructions.
Line 1 asks for your “unearned income” as defined above. If you had no earned income (i.e., you were 100% on fellowship for the calendar year and had no other income sources), you can use the value from your Form 1040 Line 1. If you had both earned and unearned income, you need to fill out the Unearned Income Worksheet (p. 2 of the form instructions), which subtracts your earned income from your total income.
If you took the standard deduction, enter $2,200. If you itemized your deductions on Schedule A, there is a different formula to use in the instructions.
Line 3 = Line 1 – Line 2
If the value in Line 3 is 0 or negative, you do not have to pay the Kiddie Tax. (Translation: If you took the standard deduction and your unearned income is less than $2,100, you do not have to pay the Kiddie Tax.)
Enter in Line 4 your taxable income from Form 1040 Line 11b (your gross income minus all relevant deductions).
Enter in Line 5 the smaller of the values in Line 3 and Line 4.
To calculate your tax, you have to use the Line 7 Tax Computation Worksheet on p. 4 of the instructions or the Tentative Tax Based on the Tax Rate of Your Parent Worksheet on p. 5. The first worksheet applies the tax rates for estates and trusts to your unearned income; it is likely more advantageous to you to elect to use the second worksheet, but you will need to know your parents’ and siblings’ incomes for the calculation.
How to Avoid the Kiddie Tax
Once a tax year ends, you run out of opportunities to avoid the Kiddie Tax. To avoid the Kiddie Tax in the current or a future tax year, make sure that at least one of the five above points on who the Kiddie Tax doesn’t apply to is true for you. For example, you could:
- Delay your matriculation into grad school
- Configure your income and expenses such that you pass the support test, e.g.,
- Request that you are paid by an assistantship instead of a fellowship for part or all of the calendar year
- Earn a significant side income
- Get married and file a joint return.
- Find every applicable qualified education expense to make more of your fellowship income tax-free (e.g., your student health insurance premium if paid by scholarship)
How to Minimize the Kiddie Tax
If you are subject to the Kiddie Tax, the best thing to do is minimize your unearned income and taxable income. If you have any influence with your parents and they are willing and able to minimize their taxable income, please ask them to do the same.
You can minimize your unearned (awarded) income by making as much of it tax-free as possible using your qualified education expenses. This is largely accomplished more or less automatically, but please be thorough in tracking down and documenting every possible qualified education expense, such as course-related expenses and certain fees. Box 1 of your Form 1098-T is likely not the full sum of your qualified education expenses for this purpose.
You can minimize your taxable income by taking additional above-the-line deductions or adjustments to income, such as contributing to a traditional IRA (through April 15 of the subsequent year) or paying student loan interest (during the tax year).
The fact that fellowship income triggers the Kiddie Tax is unconscionable and potentially highly financially damaging to an already vulnerable population, graduate students funded by fellowship or awarded income. Despite their lack of earned income, these graduate students are typically financially independent from their parents, so their parents’ income, even if high, is immaterial to their lives. This aspect of our tax code desperately needs reform; however, I am not hopeful that it will be reformed in the near future as it has withstood two recent tax code updates.
There are two broad categories of PhD trainee income: employee income and awarded income. Employee income is W-2 pay, whereas awarded income is any other regular type of income for a graduate student or postdoc, e.g., Form 1098-T Box 5 or Form 1099-MISC Box 3 or 7. For US citizens and residents, both employee and awarded income are supposed to be reported in the ‘wages’ line on your tax return, i.e., Form 1040 Line 1. For non-residents (e.g., some international students and postdocs), other lines on Form 1040-NR and Form 1040-NREZ are used. Read on for the relevant tax code references.
Where to Report Employee (i.e., W-2) Income
Compensatory income comes from work as an employee and will be reported on a Form W-2. The terms used for employees at the postdoc level vary quite a lot, but at the graduate student level the positions are usually called assistantships (research, teaching, graduate, etc.).
Your gross yearly compensatory income will appear in Form W-2 Box 1, and the income tax that has been withheld from you pay will appear in Boxes 2 (federal), 17 (state), and 19 (local).
Form W-2 contains instructions for the employee (p. 7), which state: “Box 1. Enter this amount on the wages line of your tax return.”
On Form 1040 (for US Citizens and Residents)
The wages line of your tax return is Form 1040 Line 1, which is labeled: “Wages, salaries, tips, etc. Attach Form(s) W-2.”
The Form 1040 instructions for Line 1 (p. 21) state: “Enter the total of your wages, salaries, tips, etc. If a joint return, also include your spouse’s income. For most people, the amount to enter on this line should be shown in box 1 of their Form(s) W-2.”
On Form 1040NR (for Non-Residents)
The wages line of your tax return is Form 1040NR Line 8, which is labeled: “Wages, salaries, tips, etc. Attach Form(s) W-2.”
The Form 1040NR instructions for Line 8 (p. 17) state: “Enter the total of your effectively connected wages, salaries, tips, etc. Only U.S. source income is included on line 8 as effectively connected wages. For most people, the amount to enter on this line should be shown in box 1 of their Form(s) W-2.”
On Form 1040NR-EZ (for Non-Residents)
The wages line of your tax return is Form 1040NR-EZ Line 3, which is labeled: “Wages, salaries, tips, etc. Attach Form(s) W-2.”
The Form 1040NR-EZ instructions for Line 3 (p. 6) state: “Enter the total of your effectively connected wages, salaries, tips, etc. Only U.S. source income is included on line 3 as effectively connected wages. For most people, the amount to enter on this line should be shown in box 1 of their Form(s) W-2.”
Where to Report Awarded Income
Awarded income is not given in exchange for work as an employee, and therefore no W-2 is issued. At the graduate student level, awarded income is usually called scholarships, fellowships, and grants. The titles used for postdocs receiving awarded income vary, but they are not considered employees.
Awarded income will be officially reported to the student on a Form 1098-T in Box 5, on a Form 1099-MISC in Box 3 (rarely Box 7), or on a Form 1042-S in Box 2 (for non-residents). It also might be unofficially reported on a courtesy letter or not appear on any documentation at all.
Please note that when you calculate the taxable portion of your non-compensatory income for the year, you have two choices for what to do with your qualified education expenses: to take a deduction or a credit. See How to Prepare Your Grad Student Tax Return for more details.
Publication 970 Chapter 1 discusses where to report the taxable portion of scholarships, fellowships, and grants (p. 6-7):
How you report any taxable scholarship or fellowship grant income depends on which return you file.
Form 1040 or 1040-SR. If you file Form 1040 or 1040-SR, include the taxable amount in the total on line 1. If the taxable amount was not reported on Form W-2, also enter “SCH” and the taxable amount on the dotted line next to line 1.
Form 1040-NR. If you file Form 1040-NR, report the taxable amount on line 12. Generally, you must report the amount shown on Form(s) 1042-S, Foreign Person’s U.S. Source Income Subject to Withholding, box 2. See the Instructions for Form 1040-NR for more information.
Form 1040-NR-EZ. If you file Form 1040-NR-EZ, report the taxable amount on line 5. Generally, you must report the amount shown on Form(s) 1042-S, box 2. See the Instructions for Form 1040-NR-EZ for more information.
The Form 1040 instructions for Line 1 (p. 21) state: “The following types of income also must be included in the total on line 1… Scholarship and fellowship grants not reported on Form W-2. Also, enter “SCH” and the amount on the dotted line next to line 1.”
Form 1040NR Line 12 is labeled: “Scholarship and fellowship grants. Attach Form(s) 1042-S or required statement (see instructions).”
The Form 1040NR instructions for Line 12 (p. 20) state: “If the grant was reported on Form(s) 1042-S, you must generally include the amount shown in box 2 of Form(s) 1042-S on line 12. However, if any or all of that amount is exempt by treaty, do not include the treaty-exempt amount on line 12. Instead, include the treaty-exempt amount on line 22 and complete item L of Schedule OI on page 5 of Form 1040-NR.”
Form 1040NR-EZ Line 5 is labeled: “Scholarship and fellowship grants. Attach Form(s) 1042-S or required statement.”
The Form 1040NR-EZ instructions for Line 5 state: “If the grant was reported on Form(s) 1042-S, you generally must include the amount shown in box 2 of Form(s) 1042-S on line 5. However, if any or all of that amount is exempt by treaty, do not include the treaty-exempt amount on line 5. Instead, include the treaty-exempt amount on line 6 and complete item J of Schedule OI on page 2 of Form 1040-NR-EZ.”
It’s incredible that in the US we are expected to prepare our own tax returns! Even a simple return can prove quite challenging for someone new to preparing one, so it’s natural to turn to other sources for help. Grad students have a double disadvantage in this area: 1) Their income and expenses are a bit unusual, so finding the right help can prove difficult. 2) They don’t have much available cash to pay for help. The good news is that there are numerous 100% free sources of help for your tax return.
I think the IRS should be the first place you turn for help when preparing your tax return! After all, they have the final word on how to properly fill out a tax return. The IRS provides multiple sources of 100% free help.
The central form of your tax return is Form 1040. (Non-residents will use a Form 1040-NR. In previous years, you might have used a Form 1040-A or Form 1040-EZ, but those no longer exist post-Tax Cuts and Jobs Act.) That is the one every filer will fill out. If you have a simple return, that’s where it stops, but if your return is more complex, you may have some additional schedules and forms to fill out.
Form 1040 comes with a detailed instruction booklet (not yet updated for 2019). If you’re ever confused about what the form means, just refer to that particular line in the instructions.
Interactive Tax Assistant
In addition to the PDF publications, the IRS has large set of tools known as the Interactive Tax Assistant. After selecting your question of interest (e.g., Do I Include My Scholarship, Fellowship, or Education Grant as Income on My Tax Return?), the ITA will prompt you for information and give you an answer at the end of the process.
Additionally, the IRS has instead created numerous publications to explain their interpretation of the code even more clearly.
The most relevant publications for PhDs are (not all updated for 2019):
- Publication 17, Your Federal Income Tax
- Publication 501, Dependents, Standard Deduction, and Filing Information
- Publication 970, Tax Benefits for Education
- Publication 505, Tax Withholding and Estimated Tax
- Publication 519, U.S. Tax Guide for Aliens
These publications are also frequently broken up and summarized into articles that are easily searched on the IRS website.
The IRS also provides free tax software for low-income individuals and households through its Free File system. If you have a household income below $69,000 per year, you can take advantage of it. Very well-known software providers like TurboTax® and TaxAct® have Free File versions available.
If you would rather wait on hold than sift through publications on your own, you can call the IRS Help Line during tax season. Sometimes a customer service agent can quickly answer your question and clear up your confusion.
Be warned that:
- The hotline is available from 7am to 7pm “local time.” The last time I called, local time was determine by my phone number’s area code, not the time zone where the call actually originated.
- The customer service agents don’t have access to any special information. Everything they reference is already publicly available.
Other Tax Software
If you don’t qualify for the IRS Free File software, you may be able to use free versions of other software. Software like this prompts you for relevant information to assemble your tax return, so it’s an easy way to access professional tax advice. However, if your return becomes complex enough, you may be required to pay a fee to complete and submit it.
There are plenty of non-IRS sources of tax help available online:
- My Tax Center for PhD trainees (postbac, grad student, postdoc)
- TurboTax® forums
As with anything you find online, you have to take tax information with a grain of salt. Check the source and check their references. You are not receiving advice tailored to your situation, even if you’re listening to an expert. A special word of warning for tax year 2019: Check the publication date on any articles or posts. The Tax Cuts and Jobs Act was a once-in-a-generation tax overhaul, so triple-check any information you find that was originally published for tax year 2017 or earlier.
Your University and/or Community
Your university and local civic organizations (e.g., libraries, community centers) may provide free tax help. It might even be tailored for students and/or low-income individuals. A number of universities have hosted my tax seminar, and others ask local CPAs to volunteer their time. One common program at universities and elsewhere is Volunteer Income Tax Assistance (VITA) for taxpayers earning less than $55,000 per year and others with particular needs. If you avail yourself of help from any of these sources, please be aware that the volunteers and even professionals may not be well-trained in the nuances of higher education income and expenses as relevant to PhD trainees.
When to Pay for Help
The great majority of tax information that you need to prepare your return is available to you for free. If you have the time and inclination, you could learn enough to put together a competent tax return. However, your time may be more valuable to you than the money you could spend getting more targeted and/or direct tax help. If your tax return is sufficiently complex (e.g., you own property, have investment income, are self-employed, etc.), it’s worthwhile to hire a professional tax preparer. (I vetted tax preparers last year regarding higher education benefits. Email me for a recommendation!)
My workshop for PhD trainees provides (in video format) exactly the information grad students, postdocs, and postbac need to prepare and understand their tax returns. It includes special scenarios, such as for dependents and students under the age of 24. The best component of the workshop is the live Q&A sessions, in which you can ask any questions you have after viewing the videos. Working through the components of this workshop will massively cut down on the time you need to spend researching how to prepare your tax return as it is narrowly tailored for funded graduate students.
Finally, some tax questions are just too nuanced for the answers to be clearly found for free online. In 2018, I hired a tax firm to validate my overall approach to PhD trainee taxes and research some really gnarly questions. As I learned, there is a lot of gray area when it comes to taxes! The relevant sources are the tax code, the IRS’s translation of the code (e.g., the publications), the court rulings that help interpret the code, and finally, what the IRS actually elects to enforce. If you’d like to benefit from this research (and the benefits may include a literal reduction in your tax liability!), you’re welcome to join my tax workshop for PhD trainees.
Form 1098-T is issued to many (though not all) graduate students and reflects some of their higher education income and expenses. Until this year, the 1098-T was rife with problems for funded graduate students, and in many cases caused more confusion than it clarified. The 1098-T underwent a makeover in 2018, which corrected the worst of these problems. However, the shift could cause funded PhD students to owe a larger-than-expected amount of tax in 2018.
Further reading: How to Prepare Your Grad Student Tax Return (Tax Year 2018)
What Is Form 1098-T?
Form 1098-T is a tax form generated by educational institutions to communicate the education-related expenses and income associated with an individual student. It reflects the transactions in the student’s account (e.g., Bursar’s account) from a given tax year. The form’s primary use is to document the amount of money a student (or the student’s parents) may be able to use toward an education tax benefit.
The 1098-T underwent a makeover for tax year 2018, and it has improved significantly. However, some of the issues with the prior version of the form are still causing problems in 2018. This article outlines those problems and their solutions.
What Does the 1098-T Communicate?
A few of the fields on the 1098-T are most relevant to funded PhD students.
Box 1 Payments Received
This box reflects the amount of money paid on your behalf or by you for tuition and related fees. For example, if your department pays for your tuition, the amount of the tuition will show up in Box 1.
Box 2 Amounts Billed
This box is no longer in use in 2018, but many (most?) universities used it until 2017. Box 2 also reflects tuition and related fees, but it is a sum of the charges billed in the tax year rather than the amounts paid. A bill could be issued in one tax year and not be paid until the subsequent tax year.
Box 5 Scholarships and Grants
This box reflects the scholarships, fellowships, and/or grants received by the student in the tax year. The money that paid your tuition and fees will show up in this box. The fellowship (or other non-compensatory income) that paid your stipend or salary may or may not be included in this box.
This box is checked if any bills or payments for a term beginning in January through March of the following tax year were included on the current year’s 1098-T. For example, if your university received payment in December for a term starting in January, this box will be checked.
This box is checked if you are a graduate student.
The remainder of this article reviews the problems with the 1098-T and how they can be ameliorated.
Problem #1: Academic Year and Calendar Year Misalignment
Box 7 concerns the misalignment between the academic year and the calendar year.
Bills and Payments to Your Student Account
Ideally, the bills and payments for a given term will all show up on the 1098-T for the same calendar year in which the term falls.
Each fall term is like that: you may be billed or make a payment a month or two prior to the start of the term, e,g., in August for a term starting in September, but all the charges and scholarships and payments are done in the same calendar year.
However, for spring terms, you may be billed and perhaps make payments at the end of one calendar year for a term beginning in January to March of the next calendar year. In this case, the 1098-T for the earlier tax year is the one that reflects those expenses, and if a tax benefit is in order, it can be taken in the earlier year.
Historical Billing Practices for the 1098-T
In 2017 and prior, this caused a significant though largely unnoticed problem for funded graduate students (or anyone receiving scholarships): A university could post a bill for a spring term in December of the prior year, for example, and not post the scholarship that paid that bill until the start of the term in the later calendar year. That means that the earlier year would have an excess of expenses in Box 2, while the later year would have an excess of income. If not corrected, this could result in a tax deduction or credit in the earlier year and excess taxable income in the later year.
Imagine a typical fully funded graduate student at a university that had its accounting system set up this way and that used Box 2 on the 1098-T. (This was a common scenario.) In the student’s first calendar year, there would be two semesters of expenses billed but only one semester of scholarships posted. If the student used the numbers from the 1098-T without correction, he would be eligible for a tax break in that first year (or his parents would take it if he were a dependent). Each subsequent calendar year would have an equal number of terms of expenses and scholarships posted, which would probably result in small, not very noticeable discrepancies between the expenses and income. However, in the student’s final year, the system would catch up, and there would be scholarships posted with no corresponding expenses, resulting in excess income and excess tax due. In some cases, the extra tax due could exceed the value of the tax break taken in the earlier year. (Not to mention that if the student were a dependent in that first year his parents would have received the tax break, whereas he has to pay the extra tax himself in the last year.)
The correction that should have been performed throughout these years when a scholarship and the expense the scholarship paid showed up on different years’ 1098-Ts is to match up in the same calendar year the expense billed with the scholarship that paid the expense. Typically, that would mean not using an available tax benefit in an earlier year and preferring to use it in the later year that the income came in. When the expense and the scholarship that pays the expense are used in the same calendar year, the scholarship can be made tax-free using the expense if it is qualified. Specifically, you would report the relevant qualified education expenses in the later year rather than the earlier, meaning that the 1098-T in both years would be inaccurate / need adjustment.
What Changed in 2018?
Starting in 2018, Box 2 has been eliminated. This means that all universities now have to report payments received for tuition and related fees in Box 1. If the university switched its reporting system between 2017 and 2018, Box 3 is checked.
This is a much better system going forward for funded graduate students. It means that when a scholarship is posted to the student account to pay for tuition and related fees, that amount will show up in Box 5 and Box 1 in the same year, since they are the same action. It doesn’t matter if that happens in the same calendar year as the term or an earlier calendar year, because they will always be reported together.
However, this change causes two potential problems in 2018 for students at universities that made this switch.
1) If a charge was billed at the end of 2017 for a term stating in the first three months of 2018 and the bill was paid in 2018, the same expense will show up on both the 2017 and 2018 1098-Ts, first in Box 2 and then in Box 1.
Therefore, anyone receiving a 1098-T with Box 3 checked must determine whether one or more of the expenses summed in Box 1 was already used to take an education tax benefit in 2017. If that is the case, the expense cannot be used again in 2018.
2) This change in accounting systems also may force the unbalancing issue I described earlier for students finishing grad school. 2018 could be the year that there is excess income with no expenses available to offset it (after correction). If this happens, the student can either choose to pay the extra tax in 2018 or file amended returns going into the start of grad school when this problem originated (up to 3 years) to match up all the prior scholarships and expenses properly. This would still result in extra tax paid now, though it may be less than if the problem remained unamended.
The good news is that after catching up in 2018 if necessary, starting in 2019 the 1098-T will be much more straightforward.
Problem #2: Qualified Education Expenses Are Incomplete
The tuition and related fees reported on the 1098-T are not quite synonymous with the “qualified education expenses” you use to take an education tax benefit. In fact, there are different definitions of qualified education expenses depending on which benefit you use. Most likely, the amount listed in Box 1 is the amount of qualified education expenses the student has under the most restrictive definition for the Lifetime Learning Credit or the American Opportunity Tax Credit.
The definition of qualified education expenses for the purpose of making scholarship and fellowship income tax-free is more expansive. It includes certain required fees and expenses that were excluded from the definition of QEEs for the other education tax benefits, such as student health fees and required textbooks purchased from a retailer other than the university.
To find these additional qualified education expenses, check your student account, bank account, and saved receipts. Then, net them against your excess scholarship and fellowship income to make the income tax-free.
Problem #3: Not All Students Receive One
When Box 5 of the 1098-T exceeds Box 1 for a given student, the university does not have to generate a 1098-T. Some universities, as a courtesy, generate 1098-Ts for all students regardless of the Box 5 vs. Box 1 balance. This inconsistency generates confusion among graduate students and leads to the information in the student account being ignored.
It is clear that the 1098-T was not designed with funded graduate students in mind. Ideally, the 1098-T would be completely redesigned or a new form would be created to assist graduate students in preparing their tax returns. Until that happens, the 1098-T is not an independently useful document as it must be considered alongside the transactions inside and outside of the student account. The makeover to eliminate Box 2 was an improvement; at least starting in 2018, the 1098-T is no longer grossly misleading.
There is one vital step grad students need to take when starting to prepare their tax returns. It’s a super simple step, but most often overlooked, and skipping it can lead to an inaccurate return or even overpaying tax. This is the step that you take before you start feeding any numbers to your 1040, your tax software, or your tax preparer, and it is to find and categorize all of your income sources (funded grad students have at least two!).
If you found this video insightful and you want to take the next step to completing your tax return – including one trick to reduce your tax due that your tax software or tax preparer can easily miss – register for my workshop, “How to Complete Your 2018 Grad Student Tax Return (and Understand It, Too!).”