Do I Have to Pay Taxes on Scholarships?
Scholarship money isn't always tax-free. How you spend the funds is the key factor in determining if your financial aid is considered taxable income.
Scholarships and grants are a common method for funding higher education, but this financial aid is not always tax-free. The taxability of scholarship funds hinges on a specific set of circumstances defined by the Internal Revenue Service (IRS). Understanding these rules is important for proper tax filing and avoiding unexpected liabilities.
Determining if a Scholarship is Tax-Free
For a scholarship or fellowship grant to be entirely tax-free, the recipient must be a degree candidate. This means you are pursuing a degree at a college or university, or attending a primary or secondary school that offers a recognized credential. Scholarships received by non-degree candidates are considered taxable income.
The funds must be received from an eligible educational institution. The IRS defines this as an institution whose primary function is formal instruction and which maintains a regular faculty, curriculum, and an enrolled student body. This definition includes most accredited colleges, universities, and vocational schools.
Finally, the scholarship money must be used for qualified education expenses. According to IRS Publication 970, these expenses include tuition and fees required for enrollment or attendance. They also cover costs for books, supplies, and equipment that are required for courses, not just suggested or recommended.
When Scholarship Money Becomes Taxable
Scholarship funds that are not used for qualified education expenses are considered taxable income. This includes any portion of a grant used to pay for living expenses such as room and board, travel, or optional equipment. If your scholarship award exceeds the total cost of tuition, required fees, and mandatory course materials, that excess amount must be reported as income.
A scholarship or fellowship grant also becomes taxable if it represents payment for services. If a grant requires the recipient to perform work, such as teaching or research, it is treated as compensation for that labor. In these situations, the institution providing the funds will issue a Form W-2, and the amount is reported as wages.
The responsibility for determining the taxable portion of a scholarship rests with the student. It is the student’s use of the funds that dictates the tax treatment, regardless of how a university may designate certain payments. You should keep detailed records of your qualified education expenses to substantiate the tax-free portion of your aid.
Calculating and Reporting Taxable Scholarship Income
To determine the amount of taxable scholarship income, start with the total amount of all scholarships and grants you received during the calendar year. From this total, subtract the amount you paid for qualified education expenses. The remaining amount is the portion that is considered taxable income and must be reported on your federal tax return.
For example, if you received $25,000 in scholarships and paid $20,000 for tuition and required fees, plus $1,000 for mandatory books, your qualified expenses would be $21,000. The taxable portion of your scholarship would be $4,000. This amount must be included in your gross income, and you must use amounts from the calendar year, not the academic year.
This taxable income is reported on your Form 1040. You will include the taxable amount on Schedule 1 (Form 1040) on the line designated for scholarship and fellowship grants. Information from Form 1098-T, “Tuition Statement,” which you receive from your educational institution, can help you determine your qualified expenses.
Special Considerations for Other Financial Aid
Federal Pell Grants are treated in the same manner as other scholarships. They are tax-free as long as they are used to pay for qualified education expenses. Any portion used for non-qualified expenses, such as room and board, would be considered taxable income.
Fulbright grants, which are often awarded for research or teaching abroad, are considered taxable income. These grants are viewed as payments for services rendered, and therefore the amounts are included in the recipient’s gross income.
Qualified tuition reductions are often provided by an educational institution to its employees or their dependents. These reductions are not considered taxable income for undergraduate education. For graduate students, the reduction is only tax-free if it is in exchange for teaching or research activities.