2023 UPDATE: For 2023, the Standard Deduction for a dependent is either $1,250 or Earned Income plus $400, whatever is higher. Under the "Kiddie Tax," the first $1,250 in unearned income is not taxed, the next $1,250 is taxed at the child's marginal rate, and unearned income over $2,500 is taxed at the parent's marginal rate.
Because the "Kiddie Tax" only kicks in at twice Melissa's Standard Deduction. The amount between $1,150 and $2,300 ($1,250 and $2,500 for 2023) is taxed at Melissa's marginal rate of 10%.
The trick is explaining it in a way most people would understand it. Once way to get AOTC when scholarships exceed tuition paid is for the dependent child to report the scholarship as income (the scholarship must be able to be used for living expenses, such as a Pell Grant) and pay tax on it. The parents could then take the AOTC. But, since scholarships treated as income constitute "unearned income," that income might be large enough to trigger "Kiddie Tax."
