Tax Issues Associated with Reporting Fellowships David Won Tax

Tax Issues Associated with Reporting Fellowships David Won Tax Compliance Manager-University of California Office of the President-CFO Division Benjamin Tsai Senior Tax Analyst Marcia Johnson Tax Analyst Jennifer Lim Tax Analyst March 09, 2022 1

Scope This presentation applies to UC graduate students This is not intended to provide tax advice; it is informational only and points to published resources such as the IRS and Franchise Tax Board. Please consult your personal tax advisor for more information 2

Tax Filing Question What is the deadline for filing your 2021 Income Tax Return? April 18, 2022 3

Fellowship Grants How does the IRS treat fellowship grants for income tax purposes? Fellowship payments are taxable, unless they are excluded from taxable income under Section 117(a) of the Internal Revenue Code Non-compensatory fellowship grants need to be reported on your tax return because they are “nonqualified” fellowships, as explained in later slides 4

Compensatory Fellowship Grants A grant represents compensation for services if either of the following apply: There is a requirement for past, present, or future teaching, research, or other employment services by the recipient; or The grant payment enables the recipient to "pursue studies or research primarily for the benefit of the grantor.” Therefore, the compensation received by the recipients are the recipients’ gross income, and must be reported as gross taxable income on the recipients’ income tax returns may be subject to OASDI and Medicare. 5

Income Calculation: Taxable versus Nontaxable Scholarships and Fellowships Scholarships and Fellowships are Nontaxable if they are used for: tuition and fees (both academic and nonacademic) required for the enrollment or attendance of the University books, supplies, and equipment required for courses of instruction at the University These Nontaxable Scholarships and Fellowships are referred to as “qualified” (short for “qualified tuition and related expenses” for scholarship and fellowship purposes only) 6

Income Calculation: Taxable versus Nontaxable Scholarships Taxable if used to pay for expenses other than required tuition, fees, books, supplies, equipment and any fees (both academic and nonacademic) required as a condition for enrollment. These Taxable Scholarships are referred to as “nonqualified” Example of Taxable Scholarship Payments: Room and Board Travel Other Living Expenses 7

Kiddie Tax Under age 18 or a full-time student under age 24 at the end of 2021 Child’s interest, dividends, unearned income over 2,200 IRS Form 8615, Tax For Certain Children who Have Unearned Income IRS Form 8814, Parent’s Election to Report Child’s Interest and Dividends Taxable Scholarship is included in the calculation of kiddie tax Kiddie tax is calculated at the parents' top marginal rate For 2018 & 19 years, kiddie tax was calculated at modified trust and estate tax rates Recent legislation allows for taxpayers to modify tax for 2018 & 2019 years 8

Emergency Grant Emergency financial aid grants to students such as Higher Education Emergency Relief Fund (HEERF) are not considered taxable income – signed into law on March 11, 2021 Qualified tuition and related expenses paid with emergency grant funds – Report in Box 1 of Form 1098T No consent – Discharge the student’s outstanding balance as lost revenue and reimburse through HEERF grants Consent – Once the emergency grant is provided to students, the University must receive affirmative written consent from the students before applying the funds to satisfy their outstanding account balance 9

Lifetime Learning Tax Credits Only apply to students filing as U.S. Citizens and Resident immigrants Generally student receives Form 1098-T, though it might not include all expenses like books Derived from the tax credit’s definition of “qualified tuition and related expenses” tuition required for the enrollment or attendance of the University academic fees required for the enrollment or attendance of the University books, supplies, and equipment required for courses of instruction at the University unlike nontaxable scholarships/fellowships, nonacademic fees disallowed by I.R.C. Section 25A(f)(1)(C), such as student activity fees, athletic fees, insurance expenses, or other expenses unrelated to a student's academic course of instruction, even though they are required for enrollment 10

Credit to Reduce Income Taxes Taxpayer may use Lifetime Learning Credit (Form 8863) to offset income taxes Must be U.S. citizen or resident immigrant Concept of Credit Initial income taxes are calculated before the credit is applied Only applies to federal income taxes The credit begins phasing out when modified adjusted gross income (MAGI) is at least 80,000 for single return ( 160,000 for joint return) and is no longer available when MAGI is at least 90,000 for single return ( 180,000 for joint return) for 2021. The credit is limited to a maximum 2,000 (20% x 10,000 maximum “qualified tuition and related expenses”), depending on your tax circumstances. IRS: Am I Eligible to Claim an Education Cr edit? 11

FORM 1098-T The Form 1098-T reports qualified tuition and related expenses, scholarships, fellowships, and grants administered by the University without regard for its possible taxability The Form 1098-T is generally only provided to U.S. citizens and resident immigrants 12

Example of Form 1098-T Assume: Adjusted qualified education expenses (BOX 1) 25,000 (BOX 5) 10,000 Adjusted qualified education expenses 15,000 Report the “Adjusted qualified education expenses” to reduce your income taxes 13

Example: If a scholarship exceeds qualified education expenses Assume the following: Scholarship/Fellowship grants 30,000 Qualified Tuition/Expenses 26,000 25,000 Tuition 1,000 Nonacademic Enrollment Fees (Example: Student Health Insurance) Books/Required Course Materials 500 Question: How much is taxable nonqualified scholarship/fellowship? 14

Additional Example: Nonqualified scholarship and fellowship payment amount 30,000 Box 5 – Scholarships and Grants 30,000 Box 5 – Scholarships (1,000) (subtract nonacademic fees first as best tax strategy) Box 1 – Nonacademic Fees (use this first to determine qualified scholarship) (25,000) Box 1 - Qualified tuition (500) Required Books 3,500 (taxable income because scholarships exceed expenses) Nonqualified scholarship and fellowship payment amount 15

Example: If scholarship is less than qualified education expenses Assume the following: Scholarship/Fellowship grants 20,000 Qualified Tuition/Expenses 29,000 28,000 Tuition 1,000 Nonacademic Enrollment Fees (Example: Student Health Insurance) Books/Required Course Materials 500 Question: How much out-of-pocket costs are available for the credit? 16

Additional Example: Qualified education expenses 20,000 (1,000) (subtract nonacademic fees first as best tax strategy) Box 5 – Scholarships and Grants Box 1 – Nonacademic Fees (use this first to determine qualified scholarship) (28,000) (500) Box 1 - Qualified tuition Required Books 9,500* (expenses exceed scholarship) Adjusted Qualified Education Expenses for taxpayer to take credit* *Please remember the credit has a 2,000 limit, which can be further reduced depending on your income and qualified education expenses. 17

Reporting of Nonqualified Scholarship and Fellowship Payments The University is not required to report these payments to the IRS or withhold tax on the payments. Exception: The University does have to report and withhold Nonqualified Scholarship and Fellowship Payments made to Non-immigrants on IRS Form 1042-S Graduate Students who are U.S. citizens or resident immigrants are required to self-report the total annual value of their fellowships, including benefits for themselves and their dependents, when they prepare their U.S. and California income tax returns. 18

Qualified Tuition Reduction for Teaching Assistants and Research Assistants Generally, University employees who receive tuition reductions for graduate-level courses are subject to imputed taxable income on the reduced tuition. However, Graduate Students who are employed by the University as teaching assistants or research assistants may receive tuition reduction for graduate level courses. The reduced tuition is not subject to imputed taxable income because such tuition reduction meets the requirements to be “qualified tuition reduction” under I.R.C. Section 117(d)(5). Please note that wages and salaries earned from services provided are still subject to federal and state income taxes. 19

Immigration Terminology Currently the IRS still uses older terminology Resident Immigrants This is the term that will eventually replace the term “Resident Aliens” Non-immigrants This is the term that will eventually replace the term “Nonresident Aliens” 20

Income Taxation of Nonqualified Scholarships and Fellowship Grants Federal Income Taxes Who are required to pay? U.S. citizens Resident immigrants Non-immigrants (it depends) 21

Federal Income Taxes U.S. Citizens and Resident Immigrants Subject to regular graduated income tax rates on income received from all sources. The income received from all sources include income from both within and outside the United States. 22

Federal Income Taxes Non Theseimmigrants Nonqualified Scholarships and Fellowships are reported on an IRS Form 1042-S Generally, the University has to withhold 30 percent of Nonqualified Scholarship and Fellowship payments under I.R.C. Section 1441(a). For Non-immigrants with an F, J, M, or Q visa, the University has to withhold 14 percent of Nonqualified Scholarship and Fellowship payments under I.R.C. Section 1441(a)-(b). 23

Federal Income Taxes Nonimmigrants Exceptions to Non-immigrant Withholding Laws: Foreign Source Fellowship Income Tax Treaties that reduce or eliminate U.S. withholding taxes* Grant that is a qualified scholarship or fellowship and not subject to tax withholding * For a list of income tax treaties, please visit the IRS website (www.irs.gov) and type in "United States Income Tax Treaties - A to Z" 24

Example of Form 1042-S 25

Tax Treaty Exemption A Nonqualified Scholarship or Fellowship paid to a non-immigrant may be treated as tax exempt for federal tax purposes if the non-immigrant is from a country that has a tax treaty with the United States. If the Nonqualified Scholarship or Fellowship is deemed to be exempt the non-immigrant would need to complete additional forms: Nonqualified Scholarship or Non-employee Fellowships – Form W8BEN (Certificate of Foreign Status of Beneficial Owner for United States Tax Withholding) 26

Tax Treaty Exemption IRS Publications 519 and 901 contain information on tax treaties. Contact your campus International Office to obtain access to the GLACIER Non-immigrant Tax Compliance Software which will determine treaty eligibility and assist with completing the necessary forms. 27

Dual Status Immigrants If you feel you may be a dual status immigrant for the tax year, please refer to IRS Publication 519. You may also contact the campus International Office for access to the GLACIER Non-immigrant Tax Software system which will help guide you through the residency determination process. 28

How Does the Fellow Report Taxable Fellowships? Federal Income Tax Reporting: U.S. Citizens and U.S. Resident immigrants report their Fellowship Grants on IRS Form 1040 (Line 1) Estimated Tax Payments are reported on Line 26 Since the Lines for these IRS Forms are only for amounts specified on Form W-2, the instructions indicate to write “SCH” and the fellowship amount on the following : On the dotted line next to Line 1 of IRS Form 1040 Non-immigrants report their Fellowship Grants on IRS F orm 1040NR (Line 1b) Be sure to file with Form 1040NR, not the Form 1040. IRS mistakenly sent stimulus checks to Non-immigrants due to incorrect filing for Form 1040, which could potentially affect visa status if not corrected. Recommend checking with Campus GLACIER Office to use GLACIER to print Form 1040NR. Other e-filing software might not produce Form 1040NR. 29

U.S. Citizens and Resident immigrants – 1040 Form – Page 1 SCH 10,000 10,000 30

U.S. Citizens and Resident immigrants – 1040 Form – Page 2 31

1040NR Tax Form For Non -immigrants 10,000 10,000 32

Federal Tax Resources Federal E-Filing Information: http://www.irs.gov/Filing GLACIER Tax Prep: GTP Franchise Tax Board: “Other Online Filing Options” https://www.ftb.ca.gov/individuals/efile/a llsoftware .shtml?WT.mc id HP Online AllFilingOptions& WT.svl HEf2 IRS Form Instructions: 1040 1040NR 1040-ES 33

Federal Tax Resources Publication 5307: Tax Reform Basics for Individuals and Individuals Publication 515: Withholding of Tax on Non-immigrants and Foreign Entities Publication 519: U.S. Tax Guide for immigrants Publication 901: U.S. Tax Treaties Publication 970: Tax Benefits for Education IRS Notice 87-31: Taxation of Grants IRS Website: United States Income Tax Treaties - A to Z National Taxpayer Advocate Service: http://www.irs. gov/uac/Taxpayer-Advocate-Service-6 Internal Revenue Service (IRS) Website: “Individuals”: htt p://www.irs.gov/individuals/index.html?navmenu menu1 www.irs.gov https://www.irs.gov/identity-theft-central 34

California State Income Taxes Who are required to pay? U.S. citizens Resident immigrants Non-immigrants California does not generally conform to Federal tax treaties. Residents of foreign countries who perform services in California or who receive income from California sources are usually subject to State income tax withholding. 35

California State Income Taxes Residents of California Generally, a “resident of California” for income tax purposes is someone who lives in California for more than 9 months in a tax year, files a resident tax return, registered to vote, etc. Please refer to FTB Publication 1031 for guidelines on California residency status Nonresidents of California California does not require reporting or withholding on fellowship grant payments, except for the portion that represents payment for services Fellow should review requirements for self reporting items subject to California income taxes. 36

How Does the Fellow Report Taxable Fellowships? California State Income Tax Reporting: California Residents report their Federal Adjusted Gross Income on Line 13 of FTB Form 540 California Nonresidents and Part-Year Residents report their Federal Adjusted Gross Income on Line 13 of FTB Form 540NR E-filing software should produce the FTB Form 540NR for taxpayers who are not residents of California (unlike the e-filing software issues for IRS Form 1040NR) 37

California Residents 10,000 Line 13 – Federal Adjusted Gross Income 38

California Nonresidents 10,000 Line 13 – Federal Adjusted Gross Income 39

California Tax Resources FTB Publication 1031 Guidelines for Determining Resident Status FTB Publication 1017 Resident and Nonresident Withholding Guidelines (can be found in FTB Form search) Franchise Tax Board (FTB) Website: “Individuals”: 40

California Tax Resources FTB’s Online Filing Options: FTB Form Instructions (can be found in FTB Form search): 540 540NR 41

University Resources UC Website: https://www.ucop.edu/financial-accounting /units/payroll-coordination-and-tax-service s / GLACIER Non-immigrant Tax Preparation Software 42

Thank you. Any Questions?