Here's my scenario:
DD's Scholarship: 16,000
Qualified Education Expenses: 12,000
Report method #1
Since the amount of scholarship is greater than that of qualified education, part of scholarship will be taxable, which is $4,000 (16,000 - 12,000). She will report $4,000 as income. Her incremental tax will be about $600.
FYI: DD has to file a tax return because of other income.
Report method #2
Split the scholarship into two equal portion, one used on parent's return and the remaining on DD's tax return.
On parent's return
Apply for American opportunity Credit
on our tax return, reporting $8,000 (from the scholarship) as tax-free assistance and $12,000 as the Qualified Education Expenses. The adjusted Qualified Education Expenses becomes $4,000 (12,000 - $8,000). The credit turns out to be about $2,500.
On DD's return:
Report $8,000 from the scholarship as income. The increased in tax will be about $1,300.
This method provides a net gain of $1,200 (2,500 - 1300) instead of paying $600.
Question: Is this method legitimate? I have spent quite a bit of time on Pub 970 but cannot determine whether this is allowable.
FYI: There's no restriction of how scholarship can be used.
Any comments or suggestions are appreciated.