Can You Pocket Scholarship Money?

Scholarships offer financial assistance, helping individuals cover higher education costs. These funds reduce tuition and school-related expenses. Understanding how scholarship money can be utilized and its potential tax implications is important for recipients.

Taxability of Scholarship Funds

A scholarship is an amount provided to a student at an educational institution for study. For tax purposes, scholarship funds can be tax-free or taxable, depending on conditions established by the Internal Revenue Service (IRS). Scholarship money is not considered taxable income if the recipient is a degree candidate at an eligible educational institution. An eligible institution maintains a regular faculty, curriculum, and a regularly enrolled body of students.

Scholarship funds become taxable under several circumstances. Any amount received that exceeds qualified education expenses, detailed in the next section, is subject to taxation. Funds used for incidental expenses such as room and board, travel, or optional equipment are considered taxable income. If the scholarship is payment for teaching, research, or other services required as a condition for receiving the grant, that portion is taxable.

Scholarships received by individuals who are not degree candidates, such as those in non-degree programs, are fully taxable. The recipient of a scholarship is responsible for determining which portion, if any, is taxable. This requires careful consideration of how the funds are used and the conditions under which they were awarded, helping students avoid unexpected tax liabilities.

Allowable Uses of Scholarship Money

How scholarship money is spent directly influences its taxability, with specific categories defined as “qualified education expenses.” These include tuition and fees required for enrollment or attendance at an eligible educational institution. They also encompass the cost of books, supplies, and equipment specifically required for courses. For instance, mandatory lab fees or specific software required for a class would fall under this category.

Conversely, scholarship funds used for “non-qualified expenses” are considered taxable income. Common examples include room and board, even if the student lives in on-campus housing or funds are paid directly to the institution. Travel expenses, such as commuting costs or trips not directly related to required coursework, also fall into this category. Other non-qualified uses include optional fees, equipment not explicitly required, or personal expenses like entertainment or vacations.

Funds used for research or clerical assistance not directly required for coursework, or for health insurance premiums, are non-qualified. Non-credit courses or programs not leading to a degree are also not covered by tax-free scholarship provisions, unless part of a degree program. It is important for scholarship recipients to maintain accurate records, including award letters, tuition bills, and receipts for all education-related expenses, to substantiate how funds were used. This record-keeping supports proper tax reporting and helps differentiate between tax-free and taxable portions of the scholarship.

Reporting Requirements

Educational institutions provide information related to tuition and scholarships through Form 1098-T, the Tuition Statement. This form is issued to eligible students by January 31st each year. Form 1098-T reports qualified tuition and related expenses paid (Box 1) and total scholarships or grants received (Box 5) during the calendar year. The 1098-T is an informational document and does not determine the exact amount of taxable scholarship income or eligibility for education tax credits.

Students are responsible for reporting any taxable scholarship income on their federal income tax return. For U.S. citizens and resident aliens, this income is reported on Form 1040. Taxable scholarship amounts not included on a Form W-2 are entered on Schedule 1 (Form 1040), Line 8r, for “Scholarship and fellowship grants not reported on Form W-2.” This amount then flows to the total income reported on Form 1040.

Even if an educational institution does not issue a Form 1098-T, the student remains responsible for calculating and reporting any taxable portion of their scholarship. This could occur if the scholarships received exceed the qualified expenses, resulting in no reportable tuition paid on the 1098-T. Maintaining thorough documentation, such as scholarship award letters, tuition statements, and receipts for all educational expenses, is important for accurate tax reporting. The IRS Publication 970, “Tax Benefits for Education,” provides comprehensive guidance on these reporting obligations and other education-related tax provisions.