Can excess taxable scholarships cause a dependent to be subject to the Kiddie tax?
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Yes, excess taxable scholarships can cause a dependent to be subject to the Kiddie Tax. Here is a comprehensive explanation, with legal detail and references to the Internal Revenue Code, Treasury Regulations, IRS guidance, and relevant case law.
1. Background: The Kiddie Tax
The Kiddie Tax, under IRC §1(g), is designed to tax the unearned income of certain children at the tax rates that apply to trusts and estates (or, in some years, at the parents’ marginal rate). The purpose is to prevent income shifting from parents to children in lower tax brackets.
The Kiddie Tax applies to a child if:- The child is under age 18 at the end of the tax year, or- The child is age 18 and does not have earned income exceeding half of their support, or- The child is a full-time student age 19–23 and does not have earned income exceeding half of their support,- The child has at least one living parent,- The child does not file a joint return,- The child has unearned income exceeding the threshold for the year ($2,700 in 2025).
2. What Counts as Unearned Income?
Unearned income for Kiddie Tax purposes includes all income other than earned income (wages, salaries, professional fees, and other compensation for personal services actually rendered, as defined in IRC §911(d)(2)(A)). This includes:- Interest- Dividends- Capital gains- Rents- Royalties- Taxable portions of scholarships and fellowship grants not reported on Form W-2.
3. Taxable Scholarships as Unearned Income
a. Excludable vs. Taxable Scholarships
Under IRC §117(a), amounts received as a qualified scholarship by a degree candidate at an eligible educational institution are excluded from gross income, but only to the extent the amounts are used for qualified tuition and related expenses (tuition, required fees, books, supplies, and equipment required for courses).
Amounts used for other expenses, such as room and board, travel, research, or optional equipment, are not excludable and must be included in gross income.
b. Taxable Scholarships Are Unearned Income for Kiddie Tax
The IRS and tax authorities have clarified that the taxable portion of scholarships (i.e., the amount not used for qualified tuition and related expenses) is considered unearned income for Kiddie Tax purposes, unless it is reported on Form W-2 as compensation for services (in which case it is earned income).
- If a scholarship is taxable because it is used for room and board or other nonqualified expenses, and is not compensation for services, it is unearned income.
- If a scholarship is compensation for services (e.g., teaching or research assistantships), it is earned income and reported on Form W-2.
4. How Excess Taxable Scholarships Can Trigger the Kiddie Tax
If a dependent child receives scholarships that exceed qualified tuition and related expenses, the excess is taxable and, if not compensation for services, is unearned income. If the child’s total unearned income (including taxable scholarships) exceeds the Kiddie Tax threshold ($2,700 in 2025), the Kiddie Tax applies.
Example:- A full-time student (age 20, claimed as a dependent) receives $30,000 in scholarships.- $20,000 is used for tuition, fees, and required books (excludable under §117).- $10,000 is used for room and board (taxable).- The $10,000 is unearned income for Kiddie Tax purposes.- If the student has no other unearned income, the first $2,700 is sheltered by the standard deduction for dependents, but the remaining $7,300 is subject to the Kiddie Tax at trust and estate rates.
5. Support Test and Scholarships
For purposes of the Kiddie Tax, when determining whether a student provides more than half of their own support (which can affect Kiddie Tax applicability for students age 18 or 19–23), scholarships are not considered as support provided by the student; see also IRC §152(f)(5).
6. IRS and Professional Guidance
- IRS Publication 970 and Form 8615 instructions confirm that taxable scholarships not reported on Form W-2 are unearned income for Kiddie Tax purposes.
- The Tax Adviser articles and professional commentary reinforce that excess scholarships used for nonqualified expenses are unearned income and can trigger the Kiddie Tax.
7. Summary Table of Key Points
- Qualified scholarships (used for tuition, fees, required books/supplies): Excluded from income, not subject to Kiddie Tax.
- Excess scholarships (used for room, board, travel, etc.): Taxable, included in unearned income, can trigger Kiddie Tax if above threshold.
- Scholarships as compensation for services (e.g., teaching assistant): Taxable as earned income, not subject to Kiddie Tax as unearned income.
- Scholarships not considered support for support test: For Kiddie Tax and dependency purposes, scholarships do not count as support provided by the student.
8. Conclusion
Yes, excess taxable scholarships can cause a dependent to be subject to the Kiddie Tax. If a dependent child receives scholarships that are not fully excludable under IRC §117, the taxable portion is treated as unearned income. If the child’s total unearned income exceeds the Kiddie Tax threshold, the Kiddie Tax applies, and the excess is taxed at the higher trust and estate rates.
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