What Happens If You Get Too Much Scholarship Money?

Receiving scholarships and grants can significantly ease the financial burden of pursuing higher education. These funds are often viewed as “free money” that directly reduces the cost of college. While beneficial, situations can arise where the total aid received exceeds a student’s defined educational needs, leading to specific financial implications. Understanding these potential outcomes is important for students and their families to manage their finances effectively and comply with relevant regulations.

Understanding Qualified Educational Expenses

The Internal Revenue Service (IRS) defines “qualified educational expenses” as those scholarship funds can cover without taxation. These primarily include tuition and fees required for enrollment or attendance at an eligible educational institution, and course-related books, supplies, and equipment that are mandatory for all students in a particular course.

Costs not considered qualified educational expenses for tax purposes include room and board, travel, and other personal or family expenses. Optional fees for sports, games, hobbies, or non-credit courses are also excluded. If scholarship funds cover these non-qualified expenses, that portion of the scholarship may become taxable.

Taxation of Scholarship Funds

Scholarship funds become taxable income when used for non-qualified educational expenses by the IRS. For example, while a scholarship covering tuition and books is tax-free, any portion used for living expenses like room and board, travel, or other personal costs is taxable, even if provided by the institution.

Taxability also depends on enrollment status. Only degree candidates at eligible institutions receive tax-free scholarships for qualified expenses. If not pursuing a degree, the entire scholarship or fellowship amount is fully taxable income, regardless of use. Additionally, any scholarship or fellowship payment for teaching, research, or other services required as a condition of the award is taxable income.

Taxable scholarship amounts are included in a student’s gross income and must be reported on their federal income tax return. This can increase tax liability and affect eligibility for other education-related tax credits or deductions. For example, if a student receives a $10,000 scholarship and uses $8,000 for qualified expenses and $2,000 for non-qualified expenses, the $2,000 portion will be taxable. Students should consult IRS Publication 970, “Tax Benefits for Education,” for detailed guidance.

Institutional Handling of Excess Aid

Colleges and universities have procedures to manage situations where a student’s total financial aid, including scholarships, exceeds their “cost of attendance” (COA). The COA is an estimate of the total expenses for one year, encompassing tuition, fees, room and board, books, supplies, transportation, and miscellaneous personal expenses. Financial aid offices are required by federal regulations to monitor and adjust aid packages to prevent “over-awards.”

An over-award occurs when the total aid exceeds either the student’s calculated financial need or their total COA. To resolve an over-award, the financial aid office may reduce or cancel certain aid components. Undisbursed loans are reduced first, followed by federal work-study, and then grants and scholarships, to minimize the impact on the student. This process ensures that the student does not receive more aid than allowed by federal guidelines or institutional policy.

If a student receives a direct refund check from their institution, this means that the financial aid disbursed to their student account exceeded the billed institutional charges. While this money can be used for other educational or living expenses, the portion used for non-qualified educational expenses may be taxable. Colleges are required to refund any credit balances within 14 days, often via direct deposit or check. Students are notified by the school about any adjustments to their financial aid or if a refund is issued.

Reporting Scholarship Income to the IRS

Students are responsible for determining and reporting any taxable portion of their scholarship income to the IRS. Educational institutions issue Form 1098-T, Tuition Statement, which reports qualified tuition and related expenses paid, as well as scholarships or grants received by the student. However, this form does not explicitly indicate the taxable amount of a scholarship.

The student must calculate the taxable portion of their scholarship, which is the amount used for non-qualified expenses. This taxable income is reported on Form 1040, U.S. Individual Income Tax Return, on Schedule 1 as “other income,” if it was not reported on a Form W-2.

Maintaining thorough records of all scholarship awards, qualified educational expenses, and any refunds received is important. These records help accurately calculate taxable income and support the information reported on the tax return. While Form 1098-T provides some information, it is the student’s responsibility to understand the tax implications and correctly report their income.