Are Scholarships Taxable Income? A Comprehensive Guide
Navigating the world of financial aid for education can be complex, especially when it comes to understanding the tax implications of scholarships and grants. Many students and their families wonder, "Do scholarships count as taxable income?" The answer, in short, is: sometimes. This article will delve into the intricacies of scholarship taxation, providing clarity on when scholarships are tax-free and when they are not.
Understanding the Basics of Scholarship Taxation
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.
The IRS has specific conditions for a scholarship not to be taxed. Typically, scholarships that pay for qualified educational costs at eligible educational institutions aren’t considered taxable income. The same applies to grants received to pay for specific schooling costs.
To avoid a scholarship being subject to taxation, you’ll need to spend the funds on qualified educational expenses. Whether scholarships are taxable depends on how much you receive and how you spend the funds.
Qualified Education Expenses: The Key to Tax-Free Scholarships
A scholarship/fellowship payment received by a candidate for degree is generally not taxable income to the student if it is used for "qualified expenses." The IRS defines a candidate for a degree as someone who either attends primary or secondary school (K-12) or attends college to pursue a degree.
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Qualified expenses are defined by the IRS and include tuition and required fees, and/or for books, supplies and equipment required of all students in the course. 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.
When Scholarships Become Taxable
A scholarship/fellowship used for expenses other than qualified expenses is 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 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.
Any amount used to pay for room and board or a stipend for living expenses is taxable. Examples of stipends are payments that can be used for living and incidental expenses such as room and board, travel, non-required books and personal computers, etc.
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.
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.
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Scholarships vs. Grants
Scholarships and grants, including Pell Grants and Fulbright Grants, are generally treated the same from a tax perspective.
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.
University Responsibilities and Student Obligations Regarding Stipends
Taxable scholarships are generally referred to as stipends and are payments for which no services are rendered or required. The granting department is responsible for correctly determining the amount, which should be classified as a stipend, but such determination is always subject to review and reclassification by the Tax Department. All stipends are paid through University Payables except for certain athletic living stipends, which are paid through Student Account Services.
Although these payments are taxable income to the student or scholar, the IRS does not require the university to withhold tax on the payment. In addition, the university is not required to provide the student/scholar or the IRS any type of year-end summary such as a Form W-2 or Form 1099 for these payments. However, students and scholars are responsible for reporting these payments and remitting any tax due with their personal income tax return, e.g. In some cases students and scholars may be required to make estimated quarterly tax payments to the IRS and/or State on their stipend income. Please refer to the Tax Forms and Publications to assess whether or not estimated quarterly tax payments are required. Students and scholars should maintain a record of the stipend payments they have received during the calendar year (January 1 to December 31), remembering to include payments they received by check via University Payables.
Navigating Tax Credits and Deductions
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. Scholarships and grants aren’t the only ways to get financial assistance to pay for higher education.
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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.
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.
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 $95,000 when filing as Single or $195,000 if you file as Married Filing Jointly.
Filing Your Taxes and Reporting Scholarship Income
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.
Special Cases and Considerations
It's important to note that qualifying payments received through the Department of Veterans Affairs (including the GI Bill) generally aren’t taxable if used to pay for education or training. But if a student receives payment for teaching, research or other services that are required as a condition of receiving the scholarship or grant, this money is generally considered taxable income.
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.
Furthermore, 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.
Additional Resources
Relevant IRS Publications:
- 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 (IRS Topic American Opportunity Tax Credit) and Lifetime Learning Tax Credit (IRS Topic Lifetime Learning Credit), Coverdell Education Savings Accounts (IRS Topic 310 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.
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