Is Financial Aid From the FAFSA Considered Income?
Demystify FAFSA financial aid and its income tax status. Learn how different aspects of your student aid are treated for tax purposes.
The Free Application for Federal Student Aid (FAFSA) helps students access various forms of financial assistance for higher education. The tax implications of this aid vary based on its type and utilization. This article clarifies how different forms of financial aid are treated for federal income tax purposes.
How Financial Aid is Defined
The FAFSA is an application used to determine eligibility for federal, state, and institutional aid. Through the FAFSA, students may become eligible for different categories of financial assistance.
Grants are “gift aid” that do not need to be repaid. Examples include the Pell Grant and the Federal Supplemental Educational Opportunity Grant (FSEOG), typically awarded based on financial need. Scholarships are another form of gift aid, provided by various sources, often based on merit, talents, or financial need.
Student loans represent borrowed money that must be repaid, usually with interest, after a student completes their education or falls below a certain enrollment status. Federal student loans, such as Stafford Loans and PLUS Loans, are common examples. Work-study programs allow students to earn money through part-time employment, often on campus, to help cover educational expenses. These funds are earned wages for work performed.
Financial aid is intended to cover educational costs, categorized into “qualified education expenses” and “non-qualified expenses.” Qualified education expenses include tuition, fees, and costs for required books, supplies, and equipment for courses. Non-qualified expenses encompass other living costs like room and board, travel, and optional fees.
Tax Treatment of Different Aid Types
Most financial aid used for qualified education expenses is not considered taxable income for federal income tax purposes. The taxability depends on the specific type of aid and how the funds are used.
Grants and scholarships are tax-free if the student is a degree candidate at an eligible educational institution and the funds are used for qualified education expenses. For example, a Pell Grant used for tuition and required textbooks is not taxable.
Portions of grants or scholarships used for non-qualified expenses become taxable income. If a scholarship requires the recipient to perform services, such as teaching or research, that portion is also considered taxable income. However, certain service-related scholarships, like those from the National Health Service Corps Scholarship Program, are exempt from this rule.
Student loans, whether federal or private, are never considered taxable income. This is because loans represent borrowed money that must be repaid. While loan principal is not taxable, interest paid on student loans may be tax-deductible under certain conditions once repayment begins.
Income earned through a work-study program is always considered taxable income. These earnings are treated as wages for federal and state income tax purposes, similar to any other employment income. Full-time students working part-time may be exempt from FICA (Social Security and Medicare) taxes on these wages.
Reporting Financial Aid for Tax Purposes
Institutions issue Form 1098-T, Tuition Statement, to students by January 31st each year. This form reports qualified tuition and related expenses, as well as scholarships and grants received. Form 1098-T is an important document for determining potential education tax credits or deductions.
Students should compare the amount of scholarships and grants reported on Form 1098-T (Box 5) with their qualified education expenses. If total scholarships and grants exceed qualified education expenses, the excess amount is considered taxable income. This taxable portion is reported on Form 1040, often on Line 1a as part of wages, salaries, and tips, even if not reported on a Form W-2.
If a student does not receive a Form 1098-T, or if the information appears incorrect, they should contact their educational institution. Taxpayers should maintain records of their education expenses and all financial aid received. These records can include receipts for tuition payments, books, and supplies, alongside award letters for grants and scholarships.
Work-study income constitutes earned wages. Employers, usually the educational institution, provide a Form W-2, Wage and Tax Statement, detailing earnings and any federal income tax withheld. The gross wages from the Form W-2 are then reported on Form 1040 as part of the total wages.