Surprises on Tax Treatment of Scholarships

Date01 July 2015
AuthorShirley Dennis‐Escoffier
Published date01 July 2015
DOIhttp://doi.org/10.1002/jcaf.22074
113
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© 2015 Wiley Periodicals, Inc.
Published online in Wiley Online Library (wileyonlinelibrary.com).
DOI 10.1002/jcaf.22074
Surprises on Tax Treatment
of Scholarships
Shirley Dennis-Escoffier
This column is intended to
inform corporate executives
whose children receive scholar-
ships of potential tax surprises,
both unpleasant and pleasant.
While most executives are prob-
ably aware of the kiddie tax
that can tax investment income
of children at their parents’ tax
rate, they may not be aware of
how this can affect the taxable
portion of a scholarship (such
as the portion for room and
board). A pleasant surprise,
however, is the Internal Rev-
enue Service (IRS) providing
tax planning strategies on how
including a portion of a schol-
arship in income can increase
education tax credits.
BACKGROUND ON KIDDIE TAX
The 1986 Tax Act included
many provisions intended to
eliminate tax shelters and close
loopholes as well as reduce the
overall tax rates. Congress was
particularly concerned with
tax avoidance by parents who
shifted income-producing assets
to young children in lower tax
brackets. In an attempt
to address this issue, Congress
modified the taxation of chil-
dren by eliminating the per-
sonal exemption for anyone
who could be claimed as a
dependent on another taxpay-
er’s return, limiting the stan-
dard deduction for dependents
to the greater of $500 ($1,050
for 2015) or earned income
plus $250 ($350 for 2015), and
introducing a tax on unearned
income of minor children,
known as the kiddie tax.
While the restrictions on
the standard deduction and
personal exemption apply
to all dependents, regardless
of age, the kiddie tax was
intended to discourage income
shifting by taxing the net
unearned income at the par-
ent’s marginal tax rate only for
children under age 14. Since
1986, however, the age limit
for the kiddie tax has increased
from 14 to 18 and then
expanded to include full-time
students under age 24. This
expansion to a student tax
does not appear to be policy
driven but done in a quest for
more revenue. Unfortunately,
as the age has increased, so has
the complexity.
The kiddie tax has no
impact on the child’s earned
income (wages, salaries,
tips, and other compensa-
tion received as pay for work
actually performed), which
continues to be taxed at the
child’s own tax rate. It applies
only to unearned income in
excess of a specific amount
($2,100 for 2015). Unearned
income includes not only
parental-source income but
income derived from nonpa-
rental sources such as invest-
ment income from a child’s
investment of his or her own
earnings.
A child is subject to the
kiddie tax if he or she is
(a) under age 18 at the end of
the year or (b) a full-time stu-
dent age 18 to 23 whose earned
income for the tax year does
not exceed one-half of his or
her support. Additionally, the
child must have more than
$2,100 of unearned income
for 2015, the child cannot be a
married taxpayer filing a joint
return for the tax year, and at
least one of the child’s parents
must be living at the close of
the tax year. Because the kiddie

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