Is Scholarship Considered Unearned Income?

Scholarships serve as a valuable financial resource, enabling many individuals to pursue their academic aspirations at various educational institutions. These awards are designed to support students by alleviating the significant financial burden associated with higher education. They can come from numerous sources, including colleges and universities, private organizations, and government programs.

What Qualifies as a Scholarship

For tax purposes, the Internal Revenue Service (IRS) defines a scholarship as an amount paid or allowed to a student at an educational institution to aid in the pursuit of studies. This definition also extends to fellowship grants, which are amounts provided to an individual for study or research. The intent behind these funds is to support a student’s academic journey.

To qualify as a scholarship or fellowship grant, the recipient must be a candidate for a degree at an eligible educational institution. An eligible institution is one that maintains a regular faculty and curriculum and has a regularly enrolled body of students. This framework ensures that the financial aid is directed towards formal educational pursuits.

Taxable Scholarship Amounts

While scholarships are often viewed as financial aid, certain portions can be considered taxable income. Any scholarship funds used for expenses other than qualified education expenses are generally subject to taxation. This includes amounts spent on incidental costs not directly related to course instruction.

Examples of non-qualified expenses that make scholarship funds taxable include room and board, travel, and optional equipment. Funds used for research, clerical help, or equipment not required for enrollment or attendance also fall into this category. If a scholarship covers these types of expenses, that specific portion becomes taxable income for the recipient.

Additionally, any part of a scholarship or fellowship grant that represents payment for services is taxable. This applies even if the services, such as teaching or research, are a condition for receiving the scholarship. The IRS considers these amounts as compensation for work performed.

Non-Taxable Scholarship Amounts

Scholarship funds can be entirely tax-free if specific conditions are met, primarily concerning how the money is used. A scholarship or fellowship grant is excludable from gross income if the recipient is a candidate for a degree at an eligible educational institution and the funds are used for specific “qualified education expenses.”

Qualified education expenses are precisely defined by the IRS and include tuition and fees required for enrollment or attendance at an eligible educational institution. Additionally, course-related books, supplies, and equipment that are specifically required for courses of instruction are considered qualified expenses. These expenses must be incurred at an eligible educational institution.

Expenses not directly tied to tuition, fees, or required course materials, such as room and board, transportation, and general living expenses, do not qualify for tax-free treatment.

Reporting Scholarship Income on Your Tax Return

When preparing a tax return, students must determine which portions of their scholarship are taxable. This assessment is based on how the funds were utilized, as outlined by IRS guidelines. The educational institution typically provides Form 1098-T, Tuition Statement, which is an informational document summarizing qualified tuition and related expenses paid, as well as scholarships and grants received.

Form 1098-T will show the total amount of scholarships or grants processed by the institution in Box 5. However, this form does not directly indicate the taxable amount of a scholarship; it is a reporting tool to assist taxpayers. Students must reconcile the amounts on Form 1098-T with their personal records of how the scholarship funds were spent to determine the taxable portion.

If a portion of the scholarship income is determined to be taxable, it generally needs to be reported on the student’s federal income tax return. For those filing Form 1040, taxable scholarship amounts not reported on a Form W-2 are typically entered on Schedule 1 (Form 1040), Line 8r. This line is specifically designated for scholarship and fellowship grants not reported elsewhere as wages.