How to Properly Use Scholarship Money

Receiving a scholarship can greatly reduce the financial burden of higher education. Understanding how to properly manage and utilize these funds is crucial for students. Effective financial literacy helps maximize their intended benefit and ensures compliance with relevant regulations.

Defining Qualified Education Expenses

Understanding what qualifies as an education expense is important for managing scholarship funds. The Internal Revenue Service (IRS) provides specific guidelines for “qualified education expenses” for tax purposes. These include tuition and fees required for enrollment or attendance at an eligible educational institution. Expenses for books, supplies, and equipment required for courses at the educational institution are also considered qualified.

Expenses for incidental costs, such as room and board, travel, and optional equipment, are generally not considered qualified education expenses by the IRS. While IRS definitions exist for tax purposes, individual scholarship providers or educational institutions may have their own terms and conditions. Students should consult their scholarship agreement and the institution’s financial aid office for clarity on permissible uses.

Understanding Scholarship Disbursement

Scholarship funds are typically paid out using one of two methods: direct payment to the educational institution or direct payment to the student. When funds are sent directly to the educational institution, they are applied to the student’s account to cover tuition and mandatory fees first. Any remaining balance after these institutional charges are satisfied may then be refunded to the student. This direct application ensures that educational costs are settled.

Alternatively, scholarship funds may be disbursed directly to the student. This often occurs after the institution has covered its charges, or the funds might be sent directly to the student for other qualified expenses. Some scholarship providers use electronic methods, such as direct deposit, to disburse funds to students or institutions. Regardless of the disbursement method, the funds must still be used for qualified education expenses to potentially remain tax-free.

Taxation of Scholarship Funds

The taxability of scholarship funds depends on how the money is used. Scholarships are generally tax-free if the recipient is a candidate for a degree at an eligible educational institution and the funds are used solely for qualified education expenses. Amounts spent on tuition, required fees, books, and supplies are typically not considered taxable income.

However, portions of scholarship money used for non-qualified expenses are generally taxable. This includes funds for room and board, travel, or other personal expenses. If a scholarship represents payment for services, such as teaching or research, that portion is taxable income. Students are responsible for tracking how they use their funds and reporting any taxable portions on their federal income tax returns, on Form 1040.

Educational institutions issue Form 1098-T, Tuition Statement, which reports qualified tuition and related expenses and scholarship amounts received. Box 5 on Form 1098-T shows total scholarships and grants received. While this form provides information, it does not calculate the taxable portion of a scholarship; students must determine and report any taxable amounts themselves.

Handling Unused Scholarship Money

When a student receives more scholarship money than is needed for qualified education expenses, handling these excess funds requires attention. If scholarship funds exceed qualified education expenses, the excess amount is considered taxable income. This applies to any funds not used for tuition, fees, or required course materials.

Some scholarship terms or institutional policies may permit excess funds to be applied toward future qualified education expenses. However, if funds are retained by the student and not used for qualified expenses in the same tax year they are received, they typically become taxable. Some programs may require returning unused funds to the scholarship provider. Students should review the terms of their scholarship award and consult their financial aid office to understand the implications of leftover funds.