Page 15

Tax-free educational assistance includes: • The tax-free parts of scholarships and fellowship grants (see Tax-Free Scholarships and Fellowship Grants in chapter 1); • The tax-free part of Pell grants (see Pell Grants and Other Title IV Need-Based Education Grants in chap- ter 1); • Employer-provided educational assistance (see chap- ter 10); • Veterans' educational assistance (see Veterans' Ben- efits in chapter 1); and • Any other nontaxable (tax-free) payments (other than gifts or inheritances) received as educational assis- tance. Generally, any scholarship or fellowship grant is treated as tax free. However, a scholarship or fellowship grant isn't treated as tax free to the extent the student includes it in gross income (the student may or may not be required to file a tax return for the year the scholarship or fellowship grant is received) and either of the following is true. • The scholarship or fellowship grant (or any part of it) must be applied (by its terms) to expenses (such as room and board) other than qualified education ex- penses as defined in Qualified education expenses in chapter 1. • The scholarship or fellowship grant (or any part of it) may be applied (by its terms) to expenses (such as room and board) other than qualified education ex- penses as defined in Qualified education expenses in chapter 1. A student can't choose to include in income a scholarship or fellowship grant provided by an In- dian tribal government that is excluded from in- come under the Tribal General Welfare Exclusion Act of 2014 or benefits provided by an educational program de- scribed in Revenue Procedure 2014-35, section 5.02(2) (b)(ii), available at IRS.gov/irb/2014-26_IRB#RP-2014-35. You may be able to increase the combined value of an education credit if the student includes some or all of a scholarship or fellowship grant in income in the year it is received. For examples, see Coor- dination with Pell grants and other scholarships, later. Refunds. A refund of qualified education expenses may reduce adjusted qualified education expenses for the tax year or require repayment (recapture) of a credit claimed in an earlier year. Some tax-free educational assistance received after 2022 may be treated as a refund. See Tax-free educational assistance, earlier. Refunds received in 2022. For each student, figure the adjusted qualified education expenses for 2022 by adding all the qualified education expenses for 2022 and subtracting any refunds of those expenses received from the eligible educational institution during 2022. CAUTION ! TIP Refunds received after 2022 but before your in- come tax return is filed. If anyone receives a refund af- ter 2022 of qualified education expenses paid on behalf of a student in 2022 and the refund is paid before you file an income tax return for 2022, the amount of qualified educa- tion expenses for 2022 is reduced by the amount of the refund. Refunds received after 2022 and after your income tax return is filed. If anyone receives a refund after 2022 of qualified education expenses paid on behalf of a stu- dent in 2022 and the refund is paid after you file an in- come tax return for 2022, you may need to repay some or all of the credit. See Credit recapture next. Credit recapture. If any tax-free educational assistance for the qualified education expenses paid in 2022, or any refund of your qualified education expenses paid in 2022, is received after you file your 2022 income tax return, you must recapture (repay) any excess credit. You do this by refiguring the amount of your adjusted qualified education expenses for 2022 by reducing the expenses by the amount of the refund or tax-free educational assistance. You then refigure your education credit(s) for 2022 and figure the amount by which your 2022 tax liability would have increased if you claimed the refigured credit(s). In- clude that amount as an additional tax for the year the re- fund or tax-free assistance was received. Example. You paid $7,000 tuition and fees in August 2022, and your child began college in September 2022. You filed your 2022 tax return on February 17, 2023, and claimed an American opportunity credit of $2,500. After you filed your return, you received a refund of $4,000. You must refigure your 2022 American opportunity credit using $3,000 of qualified education expenses instead of $7,000. The refigured credit is $2,250. The increase to your tax lia- bility is $250. Include the difference of $250 as additional tax on your 2023 tax return. See the instructions for your 2023 income tax return to determine where to include this tax. If you pay qualified education expenses in both 2022 and 2023 for an academic period that be- gins in the first 3 months of 2023 and you receive tax-free educational assistance, or a refund, as described above, you may choose to reduce your qualified educa- tion expenses for 2023 instead of reducing your expenses for 2022. Amounts that don't reduce qualified education ex- penses. Don't reduce qualified education expenses by amounts paid with funds the student receives as: • Payment for services, such as wages; • A loan; • A gift; • An inheritance; or • A withdrawal from the student's personal savings. TIP Chapter 2 American Opportunity Credit Page 15