Scholarships and grants are often not taxable. That’s good news if your dream school gives you financial aid, but you could end up paying the IRS something depending on how much you receive and how you spend it.
Some scholarships are slightly partially taxable.
Important Details
- The part of a scholarship that pays for tuition and fees is generally not taxable, but any amount that pays for room and board, books, or supplies that are not required for attendance may be taxable.
- A portion of your scholarship would also be taxable if it exceeded your qualifying educational expenses.
- Any “surplus” money is considered taxable income.
- The school must be on the IRS list of eligible educational institutions.
- Pell Grants are tax-exempt.
School Awarded Scholarship
Getting a scholarship doesn’t always mean someone wrote you or your school a big check to cover tuition and fees. Schools may clear your debt for the year or semester when they award full scholarships rather than receiving funding from a third party. You participate for free.
Bear In Mind
Scholarships presented by schools are usually granted for academic excellence or to recruit student-athletes into sports programs.
Grants Vs Scholarship
Grants sometimes called “fellowship grants,” are intended to be paid for a specific area of research or study. Pell Grants are an exception. They are based on need.
The financial situation of the students is so disadvantaged that they would not be able to study without this financial support. These funding sources are not considered income but may be taxable.
Where Do You Attend School?
The first qualifying rule for a tax-free scholarship is where you will attend school. You must use the money to go to what the IRS calls an “eligible educational institution”. This means that the institution’s primary purpose is to provide post-secondary education and tuition. It has one or more established curricula and an enrolled student body. Maintains a facility dedicated to teaching.
Most schools fall under this definition, so you probably assume yours is eligible.
A simple rule of thumb is that these school qualifies for participating in the US Department of Education’s student aid program. The department provides a list of these schools on its website.
Bear In Mind
Don’t assume your school is not eligible just because the Department of Education does not list it. To be sure, check with the school.
Taking a class or two now and then isn’t enough for the IRS. You must be pursuing a degree. Otherwise, the scholarship is taxable income.
Also, Read: Can Scholarship Money Be Used For Anything?
What Do Your Scholarship Pay For?
The next step is to determine how the scholarship money will be used. The funds can only be used for “qualified education expenses”. Otherwise, they are taxable.
Room and board are not qualifying educational expenses, so part of your premium is taxable if it is intended to pay your tuition and fees and provide you with a roof over your head and Meals.
The IRS assumes that the room and board portion constitutes income for you. You spend the money on personal needs.
School fees spent on necessary equipment, books, and supplies are tax-free. “Required” means your school or class teacher says you must have these items to enrol and attend a particular class.
You would have to pay tax on the scholarship if you used part of that money to buy a new laptop that is not required, although you could use it for educational purposes. The same goes for groceries, medical expenses, and insurance premiums. These costs also do not qualify.
It is also taxable if you use part of the money for transportation.
Was All The Money Used By You
What if a community organization gave you a $10,000 scholarship, but your qualifying expenses at the school you want to attend were only $8,500? This $1,500 balance would become taxable income for you.
Read the fine print as well. Some private scholarship funds may be earmarked explicitly for non-qualified expenses.
The downside is that your entire scholarship would be tax-free if you received $10,000 exclusively for tuition and fees, which will cost you $11,500 per year.
So every penny of the scholarship would go toward qualified expenses, but you would have to spend $1,500 from your pocket on the rest.
Money In order To Get Services
Why you have received the scholarship or grant is another determining factor. Was it because you were the star quarterback in your high school? That’s fine with the IRS. You can receive the money tax-free.
The same applies if you kept your grades so good that someone wanted to reward you.
If you receive the funds in exchange for services such as teaching, research or even help in the admission office, the money becomes taxable, at least the part related to the fee payment of your services. You work for it as for a salary. You may even receive a W-2 for the taxable portion related to services rendered.
The point here is to check if you are receiving the scholarship solely because you agree to do something in exchange for the money. Reread the fine print.
Typically, most scholarships are not awarded entirely in return for services rendered. One could offer an additional $1,500 or $2,000 if you perform a specific service or job.
Bear In Mind
Some grants are more probable to assert this “work for it” condition.
This rule applies even if you don’t have to begin performing service until after you graduate. It could be taxable income when you end up working for it. Your labour does not necessarily have to happen while you are enrolled.
Not All Factors Matter
Some factors do not automatically make your scholarship taxable, at least not by themselves, and if you follow the other rules. It doesn’t matter which organization or person gives you the money.
Your grandparents can even avoid paying gift taxes by sending the money directly to your school on your behalf.
Scholarships awarded by the National Health Service Corps scholarship program or the Armed Forces Health Professions Scholarship and Financial Assistance Program are exempt from the rule concerning services you provide for money.
Also, Read: How Scholarship Helps Students
Bear In Mind
Many students, work-learning-service-programs, are exempt from taxation under Section 448(e) of the Higher Education Act 1965 and Pell Grants.
Payments made under the G.I. Bill are also not considered scholarship or taxable income, either. You do not have to pay tax on your scholarship if you go to school in another country. However, you must meet all the other criteria.
Student loans are not taxable and do not constitute income. You must return the money.
How Do I Know If My Scholarship Is Taxable?
Scholarship is taxable if; please read below for more information
1. SCHOLARSHIP FOR DEGREE-SEEKING STUDENTS
Generally, a portion of your scholarship may be taxable if it exceeds your qualified tuition and related expenses in your degree program, even if you don’t receive a W-2.
Both related expenses and qualified tuition are defined by the Internal Revenue Service (IRS) as “tuition and fees needed for attendance or enrollment at the educational institution or books, supplies, and equipment needed for courses of instruction at the institution and required of all students in their course of instruction. (Note: Generally, housing expenses do not count as “qualified tuition and related expenses.”)
In a situation where your qualified tuition and related expenses for the fiscal year are surpassed by your scholarship amount for the fiscal year, a bit of your scholarship award may be taxable.
You should always contact the IRS or a qualified tax advisor with questions about the taxation of scholarships. See the IRS’s Grants, Scholarships, Student Loans, and Work Studies FAQs for more information.
Assistantships
Funds received may be considered taxable income if you receive a teaching or research grant. Make inquiries from the IRS or a qualified tax professional. You can also read the IRS’s Frequently Asked Questions on Grants, Fellowships, Student Loans, and Work Studies.
2. SCHOLARSHIP FOR NON-DEGREE STUDENTS
If you are not a degree student, the entire scholarship amount is subject to federal income tax, even if it is spent on educational expenses.
If you have questions about the taxation of scholarship received as a non-degree student, contact the IRS or a qualified tax advisor. You can also read the IRS’s Frequently Asked Questions on Scholarships, Grants, Student Loans, and Work Studies.
3. ALL STUDENTS (Federal Work-Study, Student Employment)
All funds received as a result of your work (i.e., federal work studies, student employment, and some scholarships) are considered earned income and, therefore, subject to federal, state, and local tax withholding.