Navigating the Tax Landscape of Scholarships and Grants
College is a significant investment, and scholarships and grants can provide crucial financial assistance. However, understanding the tax implications of these funds is essential for students and their families. This article explores when scholarships and grants are considered taxable income and how to navigate the relevant IRS regulations.
General Principles of Scholarship Taxation
Generally, a scholarship or fellowship is tax-free if you are a degree candidate and the award is used to pay for tuition and required fees, books, supplies, and equipment. Scholarships and grants, including Pell Grants and Fulbright Grants, are generally treated the same from a tax perspective. The IRS has specific conditions for a scholarship not to be taxed.
According to section 117 of the Internal Revenue Code, a "qualified scholarship" is defined as scholarships and fellowships used to pay:
- Tuition and fees required to enroll at or attend an eligible educational institution.
- Course-related expenses, such as fees, books, supplies, and equipment that are required for the courses at the eligible educational institution.
An eligible educational institution provides programs with full course credits toward college degrees, or they offer training programs for students seeking gainful employment in recognized occupations. A degree-seeking student pursues studies for an associate, bachelor’s, or higher degree at an eligible education institution.
When Scholarships Become Taxable
While many scholarships are tax-exempt, certain circumstances can render them taxable. Any amount used to pay for room and board or a stipend for living expenses is taxable. 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 you receive scholarship funds that exceed your qualifying educational expenses, the amount above these necessary costs is subject to taxation. 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.
Read also: Camp Scholarships Guide
Here's a breakdown of situations where scholarships may be taxable:
- Non-Qualified Expenses: Any portion of a scholarship, fellowship, or grant used for nonqualified expenses such as room and board, travel, research, medical insurance, optional equipment, etc., could be included in your taxable income for the year.
- Services Required: Amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant are taxable. 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.
- Excess Funds: 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.
Scholarships vs. Grants
Scholarships and grants are both forms of financial aid that help students fund their education, but they differ in their awarding criteria. 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 and are generally awarded based solely on financial need.
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.
Education Tax Credits: American Opportunity and Lifetime Learning
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.
American Opportunity Credit
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.
Read also: Benefits of NSHSS Scholarships
Lifetime Learning Credit
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.
Coordination Restrictions
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. There are also a variety of coordination restrictions that are intended to ensure that you don’t double-dip when taking advantage of the Education Tax Benefits.
Other Tax Considerations for Students
Student Loan Interest Deduction
Another useful tax deduction you may be able to claim comes from the student loan interest deduction. For 2025, you can deduct the student loan interest paid if your modified adjusted gross income (MAGI) is below $100,000 when filing as Single or $200,000 if you file as Married Filing Jointly.
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. 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.
IRS Resources and Assistance
The IRS provides numerous resources to help students and their families navigate the complexities of scholarship taxation. Relevant IRS Publications include:
Read also: Scholarship Guide
- IRS Publication 970: Tax Benefits for Education
- IRS Publication 17: Your Federal Income Tax
- IRS Notification March 2021: Emergency aid granted to students due to COVID is not taxable
IRS Publication 970 discusses scholarships and fellowships, deducting work-related educational expenses, and the various tax benefits for education, such as the American Opportunity and Lifetime Learning Tax Credits, Coverdell Education Savings Accounts, and section 529 prepaid tuition and college savings plans. See also IRS Tax Topic 513 - Educational Expenses and other IRS tax topics of interest to students.
Students whose financial aid application is selected for verification may be required to submit IRS Form 4506-T: Request for Transcript of Tax Return or IRS Form 4506: Request for Copy of Tax Return.
The IRS has also partnered with several organizations to help people prepare and file their federal individual income tax returns for free.
Reporting Taxable Scholarships
If filing Form 1040, Form 1040-SR, or Form 1040-NR, and the taxable portion was reported to you in box 1 of Form W-2, include the taxable portion in the total amount reported on Line 1a of your tax return. If filing Form 1040 or Form 1040-SR, include the taxable portion in the total amount reported on the “Wages, salaries, tips” line of your tax return. Subtract the amount you used for required expenses from the total amount of scholarships, fellowships, and grants you received.
For other taxable scholarship, fellowship, or grant amounts, where no taxes are withheld, you may need to make estimated tax payments, depending on your individual circumstances.
Taxability 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.
Seeking Professional Advice
The taxability of scholarships, fellowships, and/or grants are based upon each person’s individual facts and circumstances. This information only introduces you to the possible tax consequences of scholarship, fellowship, or grant amounts; therefore, you should contact your personal tax advisor with any questions or concerns. You also may find the IRS Pub. No. helpful.
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