Does Scholarship Money Have to Be Used for School?

Scholarships serve as a valuable form of financial assistance, helping students manage the increasing costs associated with higher education. Understanding the tax implications of scholarship money is important for recipients. The Internal Revenue Service (IRS) has specific rules governing whether scholarship funds are considered taxable income, largely depending on how the money is used. This article clarifies what constitutes qualified education expenses, when scholarship funds become taxable, and how to report scholarship income.

Defining Qualified Education Expenses

The Internal Revenue Service (IRS) outlines specific criteria for “qualified education expenses” for tax purposes. These are the expenses scholarship money can cover without being considered taxable income. Qualified expenses primarily include tuition and fees required for enrollment or attendance at an eligible educational institution.

Fees, books, supplies, and equipment required for courses at the educational institution are also considered qualified expenses. For example, if a specific textbook is mandatory for a class, or specialized equipment is necessary for a lab, the cost of these items can be covered by a scholarship without tax implications.

Conversely, many common student expenses are not considered qualified education expenses by the IRS. These include room and board, even if the student lives on campus. Other non-qualified expenses are travel costs, optional fees, and personal living expenses like laundry or entertainment. If scholarship funds are used for these types of expenses, that portion of the scholarship becomes taxable. This distinction is important for students to manage their scholarship funds effectively.

Understanding Taxable Scholarship Funds

Scholarship money becomes taxable income under specific conditions: when it is not used for qualified education expenses or if it represents compensation for services. Any scholarship amount that exceeds the total qualified education expenses, such as tuition, required fees, books, and supplies, is generally considered taxable. For instance, if a student receives a $10,000 scholarship but only incurs $6,000 in qualified expenses, the remaining $4,000 is taxable income. This excess portion must be included in the student’s gross income, even if it covers living costs like housing or food.

Scholarship funds also become taxable if received as payment for services. If a scholarship requires the recipient to perform duties such as teaching, research, or other work, the amount attributable to these services is taxable. This applies even if the services are related to the student’s field of study. The entire amount received for such services is considered taxable and is not offset by qualified education expenses.

Reporting Scholarship Income

Students typically receive Form 1098-T, Tuition Statement, from their educational institution by January 31st each year. This form provides information including the amounts billed for qualified tuition and related expenses in Box 1 or Box 2 and the total scholarships or grants received in Box 5. While Form 1098-T reports these figures, it does not explicitly state the taxable portion of a scholarship; students are responsible for determining this amount themselves. The information on Form 1098-T is used to help calculate eligibility for education tax credits and to report income.

Any portion of a scholarship that is determined to be taxable income must be reported on the student’s federal income tax return. This taxable amount is generally included on Line 1a or Line 8 of Form 1040. If the taxable scholarship income was not reported on a Form W-2, students should write “SCH” and the taxable amount on the dotted line next to the appropriate income line on Form 1040 or Schedule 1.

If the taxable scholarship amount is substantial, the student may need to make estimated tax payments, as federal income tax is generally not withheld from scholarship funds. If a student is claimed as a dependent, and their scholarship exceeds their educational expenses, the student is responsible for reporting the taxable income on their own return.