student pays parent's rate on scholarship income?
I'm having a bit of a dispute with my younger sister. She has a Master's degree in accounting, but has been a stay-at-home mom ever since getting the degree 15 years ago. I have been working 10+ years as an electrical engineer, so I'm no expert, HOWEVER, something that just happened raises my red flag, and I suggested she run the question by my tax accountant, but she's adamant she is experienced enough to know for sure....... okay, here it is:
My sister's son, my nephew, is in his second year of college in a different state than his mom, on a full scholarship for computer science. My sister makes possibly 50k running an online store out of her basement, while her husband makes over 100k as a pharmacist. My nephew has this $11k scholarship to cover his room and board (college facilities), and he earned less than $4k doing very part-time work (probably tutoring; he's incredibly smart). My sister did his taxes and is upset that he owes $2600 to the fed, and since he doesn't have that kind of money, he is being penalized to pay it in installments and must start filing quarterly for the next year (self-employed?). HERE IS THE KICKER: She is also upset that HE has been taxed at HER tax rate (income bracket for ~$150k/yr) for that scholarship instead of his tax rate (income bracket < $15k) if he was on his own, and he kind-of is! Now, I say 'on his own', because this is where I am in contention. She claims him as a dependent, and he filed with 'someone else can claim me as a dependent', and she had him claim the scholarship as his income. I told my sister it all sounds a bit wrong the way they did it, and that if she claims him as a dependent AND claimed the scholarship as HER income (which I read is the more common way parents do this), then it sounds right that the scholarship money be taxed at her high tax rate. However, my argument is, if he was not her dependent and he filed as his own dependent (not as 'someone else can claim me as a dependent'), his taxable income, including the scholarship, would be taxed at a rate that is suitable for his income bracket (~$15k/yr).
Her claim is that even a college student who is completely independent from his parents will pay taxes on the scholarship at his parent's rate, no way around it, and I just find that very hard to believe (right? I mean imagine if he had no parents or was estranged, why would he then still be paying at the parent's $150k bracket?). But, she's the expert, and unfortunately, there is no discussing matters that she is an expert on. And since she actually did her son's taxes so that he has a tax burden of $2600 out of the less-than-$4000 he made last year, I just am not letting it die! I actually think my sister should be paying that tax, since he made virtually no money and files as her dependent. That seems fair. I dunno, maybe she's right, but you know why I'm here!? Because, since she is making him pay the high taxes on the scholarship + $4k, and because I think my nephew could have saved almost $1000 in tax burden if she did not claim him and he filed as independent.
At the very least, I wanted her to entertain the idea of consulting someone with actual experience in these matters, even if she is still 'right'!
What say you all?