Did you receive a scholarship for college? If so, congratulations! Scholarships are the golden Easter eggs of the financial aid world; every student wants one, but few seem to win them. They are typically seen as “free money” for college because, unlike student loans, you don’t have to repay the money. What most students and parents are unaware of, however, is that some scholarships aren’t entirely free. That, of course, brings us to the question of the day – “Are college scholarships taxable?”
Although we’d love to give you a “yes” or “no” answer, it’s not that simple. Depending on the terms of your award and how the money is actually used, the IRS can consider your scholarship as unearned income, which is taxable. To determine if your scholarship falls into the “taxable” or “non-taxable” category, check out our guidelines below.
In general, a scholarship is considered tax-free if the following is true:
- You are a part-time or full-time college student seeking a degree
- You use the scholarship money for college tuition
- The money covers fees, books, and supplies required by the institution
For example, say you receive a $5,000 scholarship to attend your dream college and use it to pay the annual $6,000 tuition fee. In this case, your scholarship would be 100% tax-free! Keep in mind that the scholarship provider (federal, state, institutional or private) doesn’t matter and you may even use the funds to study abroad.
Situations When a Scholarship May Be Taxable
Even if you meet the above requirements, there are some exceptions to the rule.
Non-Degree Seeking Student
If you are attending college as a part-time or full-time student but not seeking a degree, your scholarship award would be taxable. The IRS requires that you be enrolled in an undergraduate, graduate, or post-graduate program. Courses for personal or professional enrichment do not count.
In addition to your enrollment status, the institution you attend must be on the government’s list of eligible colleges and universities. Most accredited public and private institutions, as well as not-for-profit schools, qualify. You can check to see if your school is eligible by reviewing the Federal School Code List. If your school didn’t make the cut, you’ll be paying taxes on your scholarship money.
It may surprise you to learn that the IRS considers housing, meal plans, and travel expenses as ineligible expenses. Common college expenses that are not eligible for tax-free status include:
- Off-campus housing
- Transportation (private or public)
- Insurance (health, renter’s, etc.)
- Medical (copays, prescriptions, etc.)
- Laptops or other electronic devices (not required by college)
Received a full-ride scholarship? The part used to pay room and board (or anything else not listed as a qualified expense) will be considered unearned income and will be taxable. For example, say you were to receive a full-ride scholarship worth $48,000. However, your tuition, fees and other qualified expenses only come to $29,000. In this situation, you would need to claim $19,000 in unearned income on your tax return.
Scholarship Funds Exceed Eligible Expenses
In January, your college will send you a 1098-T, also known as a tuition statement. This document will show the amount of qualified expenses you had, as well as scholarships you received (as reported to the college). Be aware that your 1098-T does not include books and other supplies required for your courses, so keep copies of those expenses for tax purposes. Private scholarships that were sent directly to you, and not the institution, may not be included in the totals either. Any scholarship money that exceeds the amount listed in Box 1 will be taxable. So, say you received $10,000 in institutional scholarships, as well as a $2,500 private scholarship. If your qualified expenses add up to $9,000, you would have to pay taxes on $3,500 in unearned income.
Scholarships for Service
Many schools offer students stipends or scholarships for work done on campus, such as a teaching or research assistant. Although the money may be billed as a scholarship, it’s technically earned income. Any money received in exchange for services or work will be taxable. There are, however, a few exceptions to this rule; the National Health Service Corps Scholarship Program, the Armed Forces Health Professions Scholarship & Financial Assistance Program, or work-learning-service programs managed by work colleges are exempt.
Student Loan Scholarships
If you win the unicorn of scholarships – a student loan scholarship – your award will be taxable. This is because you will be using the money to pay down your student loan debt, which is not an eligible educational expense. On the upside, you can generally deduct the taxes on the award from your winnings. So, you’ll still have more money than you did before you won the scholarship. That’s definitely a win-win situation!
Scholarships & Tax Returns
Once you determine whether you have taxable scholarships or not, the next issue is who will claim the scholarship income on their tax returns. If the scholarships do not exceed the qualified expenses as indicated on the student’s 1098-T, there will be no income to report. But when the scholarship money exceeds the amount allowed, the student or the parent must report the excess amount as unearned income. Parents will typically claim the scholarship income on their return and any eligible education credit when the following is true:
- The student is under 24 years old (as of December 31 of the tax year), and;
- Enrolled in an undergraduate program at least half time, and;
- The parent provides more than 50% of the student’s support
Students who have income that exceeds $6,100 (earned income + excess scholarship money) should report the scholarship money on their tax returns. For those with a combined income under $6,100, a tax return is not required.
Not sure if you or your parent should claim any scholarship money on your tax return? Speak with an experienced tax professional. An expert can help determine the best way to handle excess scholarship funds. They can also help you figure out how to keep your tax liability to a minimum and which educational credits or deductions you may be eligible to take.