What Portion of a Scholarship Is Taxable?

Scholarships and fellowships can introduce tax considerations. The Internal Revenue Service (IRS) has specific criteria to determine if any portion of an award is taxable income. A scholarship’s tax treatment depends on the student’s status, the type of educational institution, and how the funds are used.

Defining Key Tax-Free Conditions

For a scholarship to be tax-free, a student must meet two primary conditions set by the IRS. The first is that the student must be a candidate for a degree at an eligible educational institution. A degree candidate is someone who is pursuing a college or university degree, or enrolled in a program that is acceptable for full credit toward a bachelor’s or higher degree.

The second condition relates to the institution. An eligible educational institution is one whose primary function is formal instruction and which maintains a regular faculty, curriculum, and a regularly enrolled body of students. This includes most accredited colleges, universities, and vocational schools that are eligible to participate in federal student aid programs. If a student does not meet these criteria, the entire scholarship amount is generally considered taxable income.

Identifying Qualified Education Expenses

The tax-free status of a scholarship is determined by how the money is spent. The IRS allows funds to be used for “qualified education expenses” without being taxed. Qualified expenses include tuition and fees required to enroll at or attend an eligible educational institution.

In addition to tuition, qualified expenses cover the costs of books, supplies, and equipment that are required for courses of instruction. For these items to qualify, they must be explicitly required of all students in a particular course. For example, a personal computer is not a qualified expense, even if useful for coursework, unless the institution or a specific course syllabus mandates that every student must have one.

Any scholarship money used for non-qualified expenses is taxable. These include costs such as room and board, travel, and optional equipment. Other personal living expenses, like utilities, transportation, or non-required supplies, also fall into this taxable category.

Furthermore, any amount that represents payment for services is generally taxable. If a scholarship or fellowship requires the recipient to perform services like teaching or research as a condition of receiving the award, that portion is treated as wages. However, amounts received for services required by certain programs, such as the National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship and Financial Assistance Program, are not taxable.

Calculating and Reporting Taxable Scholarship Income

The student must subtract the total amount of their qualified education expenses from the total scholarship and grant funds received during the year. The formula is: Total Scholarship Amount – Total Qualified Education Expenses = Taxable Scholarship Income. Any positive result from this calculation represents gross income that must be reported on the student’s tax return.

For example, if a student receives a $15,000 scholarship and has $10,000 in qualified expenses for tuition and required books, the remaining $5,000 is taxable. This $5,000, which may have been used for room and board, must be included in their income for the year.

If the taxable scholarship amount was not reported on a Form W-2, it should be reported on Schedule 1 (Form 1040), Additional Income and Adjustments to Income. This amount is then included in the total income on the main Form 1040.

Educational institutions often issue Form 1098-T, Tuition Statement, which reports amounts paid for qualified tuition and related expenses. While this form is a helpful reference, the figures on it may not represent the final calculation for tax purposes, as it may not include all qualified expenses like required books and supplies purchased from an off-campus vendor. The student is responsible for tracking all expenses and reporting the correct taxable income.