Can You Keep Leftover Scholarship Money?

Scholarships provide valuable financial assistance for students pursuing higher education, often covering a substantial portion of educational costs. A common question arises when scholarship funds exceed direct academic expenses: can students keep this “leftover” money? The answer involves understanding specific definitions and tax implications. This article explores how scholarship funds are categorized, their tax treatment, disbursement methods, and the reporting requirements for any taxable amounts.

Distinguishing Qualified and Non-Qualified Scholarship Expenses

Distinguishing between qualified and non-qualified educational expenses is fundamental to determining the taxability of scholarship funds. The Internal Revenue Service (IRS) outlines specific criteria for qualified expenses. Scholarship funds used for these qualified expenses are generally not considered taxable income.

Qualified education expenses include tuition and fees required for enrollment or attendance at an eligible educational institution. Fees, books, supplies, and equipment specifically required for courses are also considered qualified expenses. These items must be mandatory for all students enrolled in a particular course for the funds to be tax-free.

Conversely, scholarship funds used for expenses beyond these qualified categories are considered non-qualified. Examples include room and board, travel expenses, and optional equipment. Funds used for research, clerical help, or supplies not explicitly required for a course also fall under the non-qualified umbrella. When scholarship money covers these types of expenses, it is considered “leftover” money and may become taxable income.

Tax Implications of Leftover Scholarship Funds

Scholarship money designated for non-qualified expenses becomes taxable income for the student. Any portion of a scholarship used for housing, meals, or personal expenses, rather than tuition and required course materials, is subject to taxation. The IRS views these amounts as income to the student.

This taxable portion of scholarship funds can impact a student’s gross income, potentially increasing their overall tax liability. For instance, if a scholarship covers tuition and also provides funds for living expenses, the money used for living expenses will likely be taxable. Scholarship funds might also be considered payment for services, such as teaching or research, which makes them taxable income.

Exceptions exist for scholarships tied to specific service programs, such as the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program. In these cases, amounts received for services may not be included in gross income. For most students, taxability depends on how the scholarship funds are used—for qualified educational expenses or other purposes.

Scholarship Fund Disbursement Methods

Scholarship funds are disbursed through various methods, directly influencing how a student might receive any “leftover” money. One common approach involves direct payment to the educational institution. The scholarship provider sends funds directly to the college or university, which then applies the money to the student’s account to cover tuition, fees, and other direct educational costs.

If the scholarship amount exceeds the direct costs billed by the institution, the excess funds are refunded to the student. This refund may be issued as a check, direct deposit into a bank account, or via a prepaid debit card. Refunds often occur after the start of the semester, once the institution has verified tuition and fees have been paid.

Some scholarship providers may pay funds directly to the student. This method gives the student more immediate control over the money, though they remain responsible for using it for educational purposes. The financial aid office at the educational institution plays a central role in managing disbursements, communicating with scholarship providers, and processing refunds. Students are expected to inform their college about any private scholarships they receive, as this can affect their overall financial aid package.

Reporting Scholarship Income on Tax Forms

Students who receive taxable scholarship income are responsible for reporting it on their federal income tax returns. Educational institutions issue Form 1098-T, Tuition Statement, to students, which reports tuition and related expenses paid, as well as scholarship and grant amounts received. Box 5 of Form 1098-T shows the total scholarships and grants disbursed by the institution during the calendar year.

Form 1098-T may not fully reflect the taxable portion of scholarship income. This is because the form reports the gross amount of scholarships, not necessarily the amount deemed taxable after considering qualified versus non-qualified expenses. Students must determine the taxable amount of their scholarship income based on how the funds were used, specifically subtracting qualified expenses from the total scholarship received.

The taxable portion of scholarship income is reported on Form 1040, specifically on Schedule 1, Line 8r, for “Scholarship and fellowship grants not reported on Form W-2.” This amount then flows to Line 8 of Form 1040. If the taxable amount was not reported on a Form W-2, students may need to write “SCH” and the taxable amount next to the appropriate line. Maintaining thorough records of all scholarship awards and educational expenses is advisable to accurately report income and substantiate any tax-free amounts.