Are College Grants Taxable? Understanding the Tax Implications of Scholarships and Grants

Navigating the world of college finances can be overwhelming, especially when it comes to understanding the tax implications of scholarships and grants. Many students and parents are unsure whether these funds are considered taxable income. This article aims to clarify the rules surrounding the taxation of college grants and scholarships, providing a comprehensive overview of when these funds are taxable and when they are not.

Overview of Scholarship and Grant Taxation

Typically, scholarships and grants that pay for qualified educational costs at eligible educational institutions are not considered taxable income. The same applies to grants received to pay for specific schooling costs. In short, whether scholarships are taxable depends on how much you receive and how you spend the funds. The IRS has specific conditions for a scholarship not to be taxed.

A scholarship is generally an amount paid or allowed to a student at an educational institution for the purpose of study. A fellowship grant is generally an amount paid or allowed to an individual for the purpose of study or research. If you receive a scholarship, a fellowship grant, or other grant, all or part of the amounts you receive may be tax-free.

Qualified vs. Non-Qualified Scholarships and Grants

The Tax Reform Act of 1986 initially defined scholarships, grants, fellowships, stipends, internships, and prizes as taxable income. However, current regulations stipulate that qualified scholarships and fellowships are not subject to taxation.

To be considered a qualified scholarship or grant, the payment or allowance must be used solely for tuition, enrollment fees, or related expenses. If any part of the total scholarships or grants received is taxable (exceeding tuition, fees, and related expenses), it is to be treated as earned income by the recipient.

IRS Guidelines for Tax-Free Scholarships and Grants

Here are the guidelines quoted directly from the IRS:

A scholarship is generally an amount paid or allowed to a student at an educational institution for the purpose of study.
A fellowship grant is generally an amount paid or allowed to an individual for the purpose of study or research.
If you receive a scholarship, a fellowship grant, or other grant, all or part of the amounts you receive may be tax-free. Amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant are not tax-free.

What Constitutes Qualified Education Expenses?

To avoid a scholarship being subject to taxation, you’ll need to spend the funds on qualified educational expenses. Generally, this means tuition and fees required to enroll or attend the eligible educational institution. The key requirement for having scholarships cover these course-related expenses tax-free is that they must be required of all students in your course.

Qualified education expenses include tuition and fees, as well as course-related expenses (such as books, supplies and equipment) required in a student’s course of instruction. They don’t include room and board, however. To qualify, expenses must be required of all students taking the particular course.

When are Scholarships and Grants Taxable?

Some scholarship funds are subject to taxation. If you have scholarship money left over after covering your qualified education expenses, you'll need to include that amount as part of your gross taxable income. If you have money left over after covering your qualified education expenses and use it on other costs, these funds generally count as taxable income.

If scholarship or grant proceeds are used for any external purposes, the money is considered unearned income and is subject to taxation. This includes funds left over after all qualified education expenses have been paid. Of course, students can use this money for other purposes, such as to pay for room and board, utilities, groceries or meals eaten out.

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Likewise, if you receive a scholarship that you use to pay for room and board, books or supplies that aren't required, these funds are generally subject to taxation.

In some cases, a scholarship is really more of a stipend, providing compensation for services while you’re in school or for services you’ll provide in the future. If you receive a scholarship with the condition that you provide services in the future, you’ll typically need to count the scholarship as income in the year you receive it.

Scholarships vs. Grants

Scholarships and grants are both forms of financial aid that help students pay for college, but they differ in their criteria and purpose. Scholarships are financial awards often given to students who meet certain need-based criteria or merit-based achievements based on their academic, athletic or extracurricular performance, or on other areas of interest like field of study, hobbies and more. Grants are a form of financial aid that don’t require repayment. Generally, grants are awarded based solely on financial need.

Depending on how the student uses scholarship funds, they are typically not considered taxable income.

Tax Implications for Non-Resident Aliens

Scholarships awarded to non-resident aliens (Vassar’s international students) are subject to withholding by the grantor (the College) at 14% on the difference between tuition and fees and total scholarships/grants awarded. The grantor must also report the withholding on Form 1042S. The Federal Withholding Tax will appear on the College bill.

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Tax Credits for Education

Scholarships and grants aren’t the only ways to get financial assistance to pay for higher education. Tax credits such as the American Opportunity Credit and the Lifetime Learning Credit can be used to reduce the cost of pursuing post-secondary education.

The American Opportunity Credit allows students or their parents an opportunity to reduce the cost of attending college through claiming qualifying education expenses as a tax credit on their federal income taxes. To claim this education tax credit, the student must be at least a half-time student who hasn’t completed the first four years of college and is working toward a degree.

In addition to required tuition and fees, the credit applies to other expenses like books, supplies and equipment, but not room, board, transportation expenses or medical insurance. The credit is equal to 100% of the first $2,000 of qualifying expenses plus 25% of the expenses in excess of $2,000.

Whether you’re pursuing a college degree, higher education coursework independent of a degree or other educational activities to develop your career, another tax credit to consider is the Lifetime Learning Credit. Like the American Opportunity Credit, this credit also reduces your tax bill on a dollar-for-dollar basis for a portion of the tuition, fees and other qualifying expenses you pay for yourself, your spouse or a dependent to enroll in qualifying coursework.

Another distinction is that you can’t double dip with these two educational credits. That means you can’t claim both the Lifetime Learning Credit and the American Opportunity Credit in the same year for the same student.

Tax Optimization Strategies

The IRS has provided some helpful guidance on how to maximize your scholarships and tax credits, delivering you the most savings possible for your situation. One tax optimization strategy works by considering some of your scholarship money as taxable income by using it for living expenses rather than applying it toward your tuition expenses. This can allow for some of your tuition expenses to be eligible for an education credit that otherwise would have been paid by the tax-free scholarship money.

In some cases, you might be better off excluding all of the scholarship from your taxable income by applying it only toward tuition expenses. For example, if you have a grant or scholarship that fully covers all of your tuition, fees, and books, then you can't claim the American Opportunity Credit because you didn't actually pay for qualifying expenses. If, instead, you claim some of the grant or scholarship as income and don’t use it for your eligible expenses, this then leaves you with some qualified expenses to pay and gives you the ability to claim the tax credit. Since up to $1,000 of the American Opportunity Credit is refundable, you can take part of a scholarship and choose to make it taxable income.

Student Loan Interest Deduction

Another useful tax deduction you may be able to claim comes from the student loan interest deduction. For 2024, you can deduct the student loan interest paid if your modified adjusted gross income (MAGI) is below $90,000 when filing as Single or $185,000 if you file as Married Filing Jointly. Any loans you take out to pay for education expenses are tax free, too. Since its money you’ll need to pay back, the amount isn’t included in income.

The "Kiddie" Tax

Another potential issue is the “kiddie” tax. This tax originally applied to children under 14 years old with unearned income, but its scope has progressively increased over the years. Now, the kiddie tax applies to some college students - specifically, children who are claimed as dependents and are under 19 years old, or full-time college students between 19 and 23 years old who have at least one living parent and aren’t married and filing joint tax returns with their spouses. College students who meet one of these definitions and have unearned income worth more than twice the standard deduction amount for a dependent must complete IRS Form 8615 to determine how much tax is owed.

Examples of Taxable and Non-Taxable Scholarship Use

Example 1: Non-Taxable

Tammy Graves receives $10,000 in scholarship/grants that is not designated for any specific use. Tammy is a degree candidate. She spends $8,000 for tuition and $700 for her books and supplies. In this case, the scholarship covers qualified education expenses and is not taxable.

Example 2: Taxable

If Tammy used a portion of the $10,000 scholarship to pay for room and board, those funds would generally be subject to taxation.

Filing Your Taxes

If filing Form 1040 or Form 1040-SR, include the taxable portion in the total amount reported on Line 1a of your tax return. If any part of your scholarship or fellowship grant is taxable, you may have to make estimated tax payments on the additional income.

All students, regardless of citizenship status, will need to maintain copies of relevant bills, receipts, canceled checks, or other documentation related to books and supplies.

To determine the taxable portion of your scholarships, fellowships, and grants:

Subtract the amount you used for required expenses (question 2) from the total amount of scholarships, fellowships, and grants you received (question 1).

Resources and Assistance

We know that this is a lot of information and it can be confusing. As you begin to file your taxes, we encourage you to reach out to people in your support system and utilize the resources offered through the IRS. In addition to the resources we have referenced above, the IRS has also partnered with several organizations to help people prepare and file their federal individual income tax returns for free. Typically, you can file your taxes as early as February and they are due in April.

At H&R Block, you can find the expertise you need. Whether you file on your own with H&R Block Online or with a tax pro. Free tax filing for students - Did you know some students can take advantage of free tax filing with H&R Block? It’s true!

With TurboTax Live Full Service, a local expert matched to your unique situation will do your taxes for you start to finish. Or get unlimited help and advice from tax experts while you do your taxes with TurboTax Live Assisted. And if you want to file your own taxes, TurboTax will guide you step by step so you can feel confident they'll be done right.

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