What Happens to Unused Scholarship Money?

Scholarships make higher education more accessible by helping students manage costs. These financial awards cover educational expenses, alleviating the financial burden on students and their families. When scholarship funds exceed direct educational costs, questions arise about the remaining money, which involves specific rules and implications.

Understanding Qualified Education Expenses

Central to understanding scholarship money is distinguishing between qualified and non-qualified education expenses. The Internal Revenue Service (IRS) defines qualified education expenses as tuition and fees required for enrollment or attendance at an eligible educational institution. These also include course-related books, supplies, and equipment mandated for enrollment or attendance. For instance, the cost of textbooks for a required course or a specific lab fee typically falls under this category.

Conversely, many common student living costs are not considered qualified education expenses for tax purposes. These non-qualified expenses include room and board, travel costs, insurance, medical expenses, and other personal living expenses. Even optional fees, such as those for athletic activities not required for enrollment, are excluded. This distinction is important because only the portion of a scholarship used for qualified education expenses is typically tax-free, establishing what constitutes “unused” scholarship money for tax purposes.

Receiving Unused Scholarship Money

When scholarship funds are awarded, they are first applied directly to a student’s institutional account by the college or university. This initial application covers direct charges such as tuition and required fees. If the total scholarship amount exceeds these direct institutional charges, the remaining balance is considered “unused” by the institution and is then disbursed to the student.

This disbursement takes the form of a direct deposit into the student’s bank account or a physical check mailed to their address. The timing of these refunds varies but often occurs after the official add/drop period for a term, allowing the institution to finalize enrollment and billing. While most institutional and many private scholarships follow this refund process, some scholarship providers may stipulate that any excess funds be returned to them rather than disbursed to the student.

Tax Treatment of Unused Scholarship Money

The tax treatment of scholarship money depends on how the funds are used. Scholarship money used to pay for qualified education expenses, as defined by the IRS, is considered tax-free income. However, any portion of a scholarship that exceeds these qualified expenses, or is specifically used for non-qualified expenses such as room and board, travel, or other personal living costs, is considered taxable income. This applies even if the money is directly disbursed to the student as a refund.

Students are responsible for reporting this taxable portion of their scholarship on their federal income tax return, on Form 1040. Educational institutions issue Form 1098-T, Tuition Statement, which reports qualified tuition expenses and grants. This form primarily aids in calculating education credits but does not always reflect the taxable scholarship portion. Therefore, maintaining detailed personal records of all qualified education expenses paid and all scholarship funds received is crucial for accurate tax reporting. The taxable scholarship amount is added to any other income the student may have and is taxed at their marginal income tax rate.

Effects on Financial Aid Eligibility

The receipt of scholarship money can also influence a student’s eligibility for other forms of financial aid. Educational institutions are required to ensure that a student’s total financial aid package does not exceed their calculated Cost of Attendance (COA). The COA is an estimate of a student’s educational expenses, encompassing direct costs like tuition and fees, and indirect costs such as room, board, books, supplies, transportation, and personal expenses.

When a student receives additional scholarships, their total aid package might exceed this established COA, leading to an “over-award” situation. In such cases, the financial aid office is obligated to adjust the student’s aid package to bring the total aid within the COA limits. Adjustments begin with reducing “self-help” aid, such as federal student loans or work-study awards, before reducing “gift aid” like federal or institutional grants. Students are encouraged to promptly inform their financial aid office about all outside scholarships received to allow for proper coordination and to avoid unexpected adjustments to their aid package.