"Order of operations" for education tax credits

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stedix1991
Posts: 20
Joined: Sun Feb 10, 2013 1:25 pm

"Order of operations" for education tax credits

Post by stedix1991 » Wed Jul 09, 2014 2:42 pm

Hi all,

I'd appreciate any guidance you all could offer.

Here are my education expenses in 2012, per statement from my university:

Qualified Tuition & Fees: 39,936
Unqualified Expenses: 16426.48
Scholarships / Grants: 50,000
Student Loans: 6,362.48

Everything adds up, i.e. (Qualified Tuition & Fees + Unqualified Expenses) = (Scholarships & Grants + Student Loans)

I claimed $2500 in Education credits for FY2012. I received a letter today from the IRS saying that my university did not verify my qualified tuition expenses via a 1098-T form. When I spoke with my university, they said that they don't issue 1098-T's if scholarships exceed qualified tuition and fees. In my case, the university issued me a scholarship to cover more than qualified tuition and fees, as it included room&board and a few other minor things. When I filed my taxes, I did so under the impression that I could apply my student loan to qualified expenses "first", thereby making qualified expenses for the tax credit, then apply my scholarship to the remaining qualified expenses, then report the remaining scholarship as earned income (marking 'SCH'). The alternative would have been applying the scholarship to my tuition "first", meaning I made no qualified expenses for the credit, but I would have reported less scholarship as income.

Obviously the way I did it saved me more money, because a credit is post-tax whereas income is pre-tax. But was this "order of operations" invalid? The university lumped qualified and unqualified expenses together, so there was no indication that my loan actually paid for one but not the other, and I presumed to go for the way that cost me less. If I am correct, any suggestions on what documentation I could provide to the IRS in my response?

Thanks for your time.

mlipps
Posts: 890
Joined: Thu Jun 21, 2012 9:35 am

Re: "Order of operations" for education tax credits

Post by mlipps » Wed Jul 09, 2014 4:14 pm

We do this all the time at my VITA site. You should be fine; I would just prepare a spreadsheet or document clearly laying all of this out for the IRS, and also include a print out of your account statement or similar from the university.

As an aside, it's bizarre you didn't get a 1098-T, as I see them often for students with high need who end up in this same situation.

MathWizard
Posts: 2917
Joined: Tue Jul 26, 2011 1:35 pm

Re: "Order of operations" for education tax credits

Post by MathWizard » Thu Jul 10, 2014 1:04 pm

Op,

The rules are somewhat frustrating on Education tax credits.
We ran into the same situation, and couldn't claim the full credit.
See IRS pub 970 for details.

The 1098-T we got showed 0 for qualified expenses, because the scholarships were applied
to qualified expenses first by the institution.

If

My understanding was that the scholarship had to allow it to be used for
non-qualified expenses (housing for example).
Note that such use made the scholarship taxable. Of course, the first
$2K of the AOC is dollar for dollar, so in the 15% tax bracket, extra income at 15%
for a full tax credit is just fine.

I checked with the school and one scholarship did not disallow use for non-qualified expenses,
so we could use some of the money we paid as tuition money.
(The non-qualified expenses had to be related to school, within the cost of attendance figure.)
We documented everything and kept it with our taxes in case of an audit. The school
wouldn't send us any documentation, so I kept a copy of my notes from the conversation
along with the date/time and person I spoke with (head of fin. aid.). Hopefully, that
would withstand an audit (who knows with tax court) but should at least show due diligence.

Good luck.

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