Understanding form 1098-T.

Clients bring a lot of documents to their tax advisers during tax season. With or without the help of tax software, tax professionals expect the numbers reported on clients' information returns to appear in logical places on their tax returns. In general, they know exactly where to find the wages reported on Form W-2, the interest income reported on Form 1099-INT, Interest Income, the nonemployee compensation or other income from Form 1099-MISC, Miscellaneous Income, and the mortgage interest expense shown on Form 1098, Mortgage Interest Statement. A quick glance at those relevant lines on Form 1040 or its attachments usually enables preparers to quickly check that they have correctly reported those amounts.

Unfortunately, not every information return is as clear. Clients with children in college or who pursue their own academic endeavors often have at least one Form 1098-T, Tuition Statement. Form 1098-T presents tax advisers with various challenges. These issues arise partly from the law (primarily Sec. 6050S) and partly from issues unique to the higher education community. By understanding these matters, a practitioner can help to ensure his or her clients' compliance and help them to receive the greatest benefit from the available credits and deductions.

Form 1098-T

Indirect relationship: One major challenge presented by Form 1098-T is that its numbers usually do not transfer directly to Form 1040 or 8863, Education Credits (Hope and Lifetime Learning Credits). Qualified tuition and related expenses (QTREs) that a client can use in computing a Hope credit (Sec. 25A(b)), lifetime learning credit (Sec. 25A(c)) or tuition-and-fees deduction (Sec. 221) usually include amounts not reported on Form 1098-T.

Reporting options: Schools have several available reporting options. Their primary choice is whether to report QTREs on the basis of the payments received or the amount billed during the calendar year; see Sec. 6050S(b)(2)(B)(i). Approximately 85% of schools responding to a 2004 survey conducted by the National Association of College and University Business Officers (NACUBO) indicated they reported QTREs on the basis of amounts billed; see "1098-T Reporting Survey Results" at www.nacubo.org/documents/business_topics/1098T_survey_results.pdf.

The amounts-billed reporting method yields numbers that are only moderately relevant to a cash-basis taxpayer, creating the need for the practitioner to understand the timing of actual events behind the reported figures. The timing presents a challenge for calculating qualified expenses, particularly for students whose scholarships are greater than their QTREs (and, thus, may have to report taxable income). The tax adviser may not be able simply to use the difference between scholarships and grants (Form 1098-T, box 5) and QTREs (box 2).

The IRS instructs schools to report QTREs in either box 1 (payments received) or 2 (amounts billed), not both. Students from schools reporting amounts billed will see nothing reported in box 1, Payments Received for Qualified Tuition, and may quickly interpret the lack of a number as no QTREs, leading to an understandable sense of concern.

In addition, schools can exclude certain (1) students from receiving Forms 1098-T and (2) transactions from the totals they report; see Regs. Sec. 1.6050S-1 (a)(2). Out of the 526 schools responding to the 2004 NACUBO survey, the exclusions chosen, in order of popularity, were:

* Students in noncredit courses: 307.

* Nonresident alien students: 292.

* Students whose tuition and fees were waived in flail: 166.

* Students whose scholarships met or exceeded QTREs for the year: 138.

* Students whose QTREs were paid through a formal third-party billing arrangement: 109.

Additionally, 71% of the schools stated that they included partial or whole tuition waivers in the amounts reported as scholarships and grants.

Even the checkboxes are subject to some interpretation. The IRS instructs schools to mark box 9 if the student "was enrolled in a program" leading to a graduate-level degree or credential. Some students working on their undergraduate degree may take a class that yields graduate-level credit, even though they have declared no intent to pursue a graduate degree. Depending on the school's data systems, that student's Form 1098-T may or may not have box 9 checked. The tax professional needs to be aware of those types of cases to keep from falsely disqualifying an undergraduate for the Hope credit.

School Environment Incomplete picture: Several items of income and expense may not be captured by a school's data-gathering processes. Textbook expenses represent the most common element of QTRES that fall outside Form 1098-T reporting, as schools typically do not track them. Client records are critical in calculating those additional (and often substantial) qualified expenses.

In addition, schools often make payments to students in ways other than their standard student-accounts system. While student employees' wages are usually captured appropriately on Forms W-2, the academic world contains many shades of gray between earned compensation and scholarships based on academic merit or financial need. Schools frequently pay "stipends" which create confusion among all parties as to their correct tax reporting. Many students spend time in campus laboratories performing research that benefits the student, the school and the greater body of knowledge in his or her chosen field. The issue is whether the student is performing services primarily for the university (i.e., earning compensation), or the student is the primary beneficiary by promoting his or her own academic endeavors (i.e., receiving a scholarship or fellowship). One potential result of this confusion is that the school may make a "stipend" payment that is captured in neither payroll reporting nor financial aid and Form 1098-T reporting.

Academic years: The financial flow of a school year does not always fit neatly into calendar tax years. Students less familiar with taxation often misunderstand Form 1098-T to report data for a school year running from fall to spring.

Year-end cutoff issues are also common. Many schools begin their spring semester or winter quarter in early January; most bill their students in November or December of the preceding calendar year. The student may or may not have paid his or her bill by December 31; that payment may not be reported in any manner in the current year by a school reporting under the amounts-billed method. Some schools present additional supplementary financial data to provide users with a fuller picture of the relevant financial transactions.

Late payers of tuition bills may also encounter a negative aspect of calendar-year cutoff. Hope and lifetime learning credits are allowed for qualified amounts paid during the calendar year for any academic period beginning in that calendar year or the following three months, under Sec. 25A. A student who pays in January 2007 for classes taken in the fall semester of 2006 is ineligible for those credits in either year, with respect to that payment.

Schools' systems may also lead them to report scholarships in the calendar year of the academic term (e.g., spring semester 2007) or according to the date they actually posted the scholarship credit to the student's account (e.g., December 2006).

Branch campuses: Schools operating on multiple campuses may use different financial systems or may have different methods of using a single system, further complicating their data gathering for Form 1098-T. Depending on their proximity, a student may attend classes on multiple campuses during the same term. Schools that operate one branch as a "feeder" to another will see this issue compounded over the course of a calendar year, as students move from the feeder system to the main campus.

Class selection: Student account data goes through frequent changes as students drop or add classes, sometimes on multiple occasions during an academic term. If a student drops and/or adds classes over a holiday break (more often occurring before the spring semester), the resulting Form 1098-T reporting does not represent the reality of the class load actually taken.

Outside payments: Some payments, such as those disbursed from a parent's Sec. 529 account, may falsely appear to the school to he scholarships awarded by outside organizations. The school's cash-processing staff has a better chance of correctly accounting for a check from "Illinois 529 Plan" than from "College Advantage."

Lost students: Many students graduate or otherwise end their studies in May or June, and do not always provide the school with updated contact information thereafter. By the time the following January rolls around, the school may not have a current mailing address for delivery of Form 1098-T. Those clients may initially appear without their Form 1098-T for the year, and may not even realize they are missing it. Schools that provide electronic access to Form 1098-T data can help to alleviate that problem.

Tax expertise: School administrators, especially those in a bursar or student-accounts office, are well-versed in the detailed nuances of the data that feed into a student's Form 1098-T. However, schools may or may not have staff members with a high level of technical tax expertise, who understand the tax implications of their data and its flow through their systems. This is typically a greater challenge for smaller schools with limited resources. Even in larger schools, finding those tax experts can be difficult, as they may reside within a broad selection of financial or legal departments.

FERPA: Educational institutions are subject to a Federal privacy law, the Family Educational Rights and Privacy Act (FERPA). FERPA's provisions heavily restrict colleges and universities from sharing a student's account information with anyone other than the student. Because of this, parents and tax preparers are sometimes left to fend for themselves in understanding Form 1098-T data and its implications. Schools require much of the direct communication to occur with the student, who may have very little understanding of the relevant tax issues and probably no idea of the questions to ask the school. This presents a distinct communication challenge for the tax adviser.

Recommendations

Keep copies: Make sure each year's tax file has a copy of the prior year's Form 1098-T, especially from schools reporting on the amounts-billed method. A preparer who receives a client's Form 1098-T should make an additional copy for the next year's file as a standard practice.

Get client documentation: The preparer should ask for documentation of qualified expense payments (including textbooks) from the client's own records. Client records clearly evidencing payment of QTREs will often carry more weight than Form 1098-T itself. There should be a written reconciliation between Form 1098-T and the tax return, kept in the tax file in case of a future IRS matching notice.

Know the software: Practitioners should familiarize themselves with their tax software's process of gathering and recording relevant education data.

Know administrators: Tax advisers should maintain a list of administrators at each school who can offer helpful explanations. While these individuals will be constrained by FERPA from discussing too much specific account detail, they will also be aware of the challenges typically faced by students and the tax professionals who use their Forms 1098-T, and can still offer some relevant guidance that may answer some questions. At the same time, the practitioner may be in a position to help the administrators, by recommending improvements to their Form 1098-T reporting for future years.

Work with clients: Clients (especially the parents of new freshmen) need to be aware of FERPA. Procrastinating parents who contact a school on April 14 to obtain a copy of their child's Form 1098-T may be unpleasantly surprised when the school refuses to provide it. FERPA puts all account authority firmly in the student's hands; to avoid problems, parents should understand its limits in advance. Such knowledgeable advice and information will increase a practitioner's worth in his or her clients' eyes.

FROM BARRY L. HOLLAND, CPA, DIRECTOR, TAX COMPLIANCE, UNIVERSITY OF CINCINNATI, CINCINNATI, OH (NOT AFFILIATED WITH GRANT THORNTON LLP)