Do I Have to Pay Taxes on My Child’s Scholarship?

Scholarships provide financial assistance for higher education, but understanding their tax implications is important. Many wonder if scholarship funds are taxable income. While a common perception exists that scholarships are entirely tax-free, this is not always the case. A scholarship’s taxability depends on how the funds are used and the student’s enrollment status.

Understanding Tax-Free Scholarship Funds

A scholarship is an amount paid to a student at an educational institution to aid in studies. For scholarship funds to be considered tax-free, specific conditions must be met according to Internal Revenue Service (IRS) guidelines. The student must be a candidate for a degree at an eligible educational institution. An eligible educational institution includes most accredited public, nonprofit, and proprietary postsecondary institutions that are eligible to participate in student aid programs administered by the U.S. Department of Education.

The scholarship funds must also be used solely for “qualified education expenses.” These expenses include tuition and fees required for enrollment or attendance at the educational institution. The cost of books, supplies, and equipment specifically required for courses at the educational institution are also considered qualified expenses.

For example, if a scholarship covers mandatory lab fees or specific textbooks required for a curriculum, those amounts would generally be tax-free. If the scholarship amount does not exceed these qualified education expenses, and the student is a degree candidate at an eligible institution, the scholarship remains untaxed.

When Scholarship Funds Become Taxable

Scholarship funds become taxable income when used for expenses not considered “qualified education expenses” or when they represent compensation for services. Funds used for incidental expenses, such as room and board, travel, and optional equipment, are taxable. Other non-qualified expenses include personal living expenses, entertainment, and non-credit courses, unless part of a student’s degree program.

Scholarships requiring students to perform services as a condition for receiving funds are taxable. Any portion of a scholarship that represents payment for teaching, research, or other services is considered taxable income. For instance, a stipend received for acting as a teaching assistant, if it’s a condition of the scholarship, would be taxable.

There are limited exceptions to this rule for scholarships requiring services. For most other scholarships tied to service, the value of those services must be included in the recipient’s gross income. Students should review scholarship terms to understand service requirements and their potential tax implications.

Reporting Scholarship Income

Once a portion of scholarship funds is determined to be taxable, this income must be reported on a tax return. Taxable scholarship income is included as part of gross income on an individual’s federal income tax return. For individuals filing Form 1040, this taxable amount is typically reported on the “Wages, salaries, tips” line or on Schedule 1. If the taxable scholarship amount was not reported on a Form W-2, the taxpayer should write “SCH” and the taxable amount in the space to the left of the relevant line on Form 1040.

Educational institutions often issue Form 1098-T, Tuition Statement, to students. This form provides details about qualified tuition and related expenses paid and scholarships or grants received during the calendar year. While Form 1098-T is a helpful resource, it is an informational document and does not definitively calculate the taxable portion of a scholarship. Students may need to refer to their own records, such as financial aid award letters and tuition bills, to accurately determine how much of their scholarship was used for qualified versus non-qualified expenses.

For scholarships that involve payment for services, and for which the institution issues a Form W-2, the taxable amount is included in the wages reported on that form. For other taxable scholarship income not reported on a W-2, it is the student’s responsibility to correctly calculate and report the amount. Tax software or a tax professional can assist in properly classifying and reporting this income, ensuring compliance with IRS regulations.