How to Read a 1098T
January 26, 2014
The big questions at work this time of year are: "When are you sending 1098T forms?" and the follow up "You filled out the wrong box". Colleges and Universities are required to file the Forms 1098-T, but the rules on what they have to include do not necessarily mesh with filling out your taxes, especially if you or your tax program don't know how to interpret them. That form can be the information that helps claim a big tax credit; or, often missed, it could be the information about scholarships that have to be claimed as income. Who claims what and where?
Reading a Form 1098T
The Form 1098T was created by the IRS after the initial education tax credits were passed into law, the Hope (now American Opportunity) and Lifetime Learning credits. There are more than just these two, but that is what started it all. The problem is, colleges and universities aren't necessarily set up to easily provide or interpret the payment information as the law reads, so the IRS allowed them an out. The result is two boxes on the form - the one you need and the one the colleges complete. Box 1 is Payments Received for Qualified Tuition and Related Expenses. This box would generally be what you need to claim the credit, simple and done. But the systems at colleges aren't set up to easily calculate this. Variables that they don't track include who made the payments and whether the payment was specifically for tuition or room or something else. For this reason, the IRS allowed them to complete Box 2, Amounts Billed for Qualified Tuition and Related Expenses. So what to do? Well the information may still be on the form, you just need to do some math and check against your statements.
Also included in the form is Box 5, Scholarships or Grants. This box is important for two reasons: it can help calculate how much is eligible for the credit; but often missed, it can also indicate that some of those scholarships are taxable. Let's first look at calculating the credit.
If your college is like the vast majority, they report on Box 2. So to get a start on what is eligible for the credit, the first step is to subtract Box 5 from Box 2. Why? Scholarships are generally applied to tuition. Also, they are only tax free to the extent that they are applied to tuition (and related expenses). I have more on when they aren't below. So, if the scholarship is paying tuition, then you did not, which makes you not eligible for the credit. Unfortunately, doing this math is not necessarily the end. Because the information on the 1098T, through quirks in the law, is not necessarily all related to the tax year in question.
It's close. But Box 2 is what was billed during the year. Colleges bill for their spring or first calendar year term usually in late November or early December. This allows taxpayers to do some planning, but makes it confusing. On the planning end, the bill isn't usually due until January, so you can decide which tax year works best by paying in either December or January. The confusion is, what did you pay? It is not always simple. For some, the information on the 1098T is all that is needed. For others, the best way is to pull out the statements from the college or request one. Things to remember: all payments you made count, including payments on credit cards and student loans (see below). Unfortunately, this whole confusion sends many to a tax advisor. If you are unsure, having one help, at least the first time through, may not be a bad idea.
What to do when scholarships exceed tuition
Some will go through the calculations above, either the simple or complex, and realize that they had enough scholarship and grant aid to not only cover tuition, but also some that pays for room and board. First comment is great! That means you earned quite a bit of free money for school. It does also mean that some of it is taxable. Scholarships or grants that exceed qualified tuition and related expenses are taxable income to the recipient. The recipient is the student, which does at least mean that the tax rate will be low.
You report this income in the same place you report wages. It can even be done on a 1040-EZ. The form should have "SCH" written just to the left of line 7 on your form 1040, 1040A or 1040-EZ.
Who claims what?
The other problem with relying on Form 1098T, and the information colleges don't track, is who paid. To qualify for the credit or deduction, you have to have made the payment and the recipient has to be your dependent. Payments by check or credit/debit card are easy for you to track. For loans, look at the borrower. Federal Direct Loans are issued to the student only, so technically not a payment from the parent. If you are a co-signer on a loan, than you likely can count it as a payment. As I stated above, scholarships are taxable to the student. This is a good thing, since students likely have a lower tax rate.
Navigating this form with tax software
Unfortunately, because the form is confusing, it is sometimes difficult to make your tax software report this properly. Frequently you have to skip the input screen for Form 1098-T. That is because the software programs want Box 1 (we all do). But as the Mick Jaggar so wisely said, you can't always get what you want. You will need to figure out how to make the program report this. Usually you can go directly to the tax form and get the number where it needs to go, usually right-clicking the line on the form. It may require reading the help file a little. Where the numbers should be:
Scholarships are reported on line 7 of Form 1040, 1040A or 1040-EZ. There is usually a place in the tax software for wage income not reported on Form W2. This is the place to input the taxable scholarship.
So in the end, taking this benefit isn't easy. Some important things to remember:
Is it worth it? Absolutely! The tax credits can reduce your tax by up to 100% of what you paid (American Opportunity Credit). Even the other options will reduce your tax by 20% or more of what you paid. More information about the options is available in this article.
While it may stink that you have to pay tax on some of your scholarships, it also means you didn't have to pay for the school. That scholarship is likely being taxed at a rate of 20%. That means 80% was free money! Scholarships are any funds paid to you. They can be the grant award the school provided, a Pell grant or SEOG, State Financial Aid, or those local rotary and foundation scholarships. On the latter, if they were sent to the college or made co-payable, then the college is including them in Box 5 of 1098T. If not, that is up to you.
And the IRS has started a project to attempt to review and collect information about how people use these forms. While not an "audit", it does mean that they will ask some people to validate the numbers they used. The IRS is using Form 1098T as the start of these reviews. That does not mean you should only use Form 1098T. Ultimately you are responsible for what's in your tax return. As long as you have the support (checks and account statements) to support what you reported, you will be fine.
For some this process can be frustrating, but I still believe that effort is worth it. For some, this may mean using a tax preparer. But paying $100 or even more for tax return preparation to save $1,000 still sounds like a good deal. Good luck.
This information is provided for general reference. None of the above should be considered as offering specific tax advice. Many individuals will have unique circumstances that require different treatment. You should examine your situation and consult a tax advisor if necessary.
References and other reading:
Education Expenses - Look At All The Options
IRS Publication 970 - Tax Benefits for Education
529 Savings Plans for Education
Avoiding a Large Bill at Tax Time
Philip Laube is a CPA in Ohio and the Assistant Vice President for Business & Finance at Muskingum University. He presents and writes about personal finance issues for college students. He can be followed at twitter and on his web site