Taxes are always a complicated issue, mainly because every household’s situation is different. But when it comes to scholarships and taxes, there are only two scenarios students and their families need to contend with, making it simpler to figure out whether the Internal Revenue Service (IRS) considers the award income.
If you or your student are confused about scholarships and taxes, here’s everything you need to know.
Do You Have to Pay Taxes on Scholarships for College
When your student lands a scholarship, two scenarios can play out. In one case, the answer to the “Do you have to pay taxes on scholarships for college” question is no. In the other, the answer is yes. That’s what makes scholarships and taxes so confusing.
However, which side of the line your student’s scholarships fall on is pretty cut and dry. Taxes on scholarships are based on how the money is used. That means all awards can potentially be tax-free scholarships. However, it also creates a situation where any award could be subject to a scholarship income tax.
Untaxed Scholarship Funds
The IRS is pretty generous when it comes to scholarships and taxes, making it possible to avoid the awards counting as taxable income by spending the money in the right way.
In most cases, your student doesn’t have to pay taxes on college scholarships if the cash is spent on qualified educational expenses (based on the IRS definition). Qualifying educational expenses include:
- Fees (including mandatory student activity fees)
- Equipment and Supplies (listed as must-haves for the course)
Essentially, if the expense is a requirement for enrolling in the college or a particular class, your student usually won’t owe taxes on the scholarship funds used to pay that cost.
It also doesn’t matter if your student pays the money to the college. For example, if your student opts to buy their books online instead of at a campus bookstore, that is still a qualifying educational expense.
Taxable Scholarship Funds
Scholarship money not used on qualifying educational expenses is considered taxable income. This includes funds spent on other expenses as well as any your student chooses to save for a rainy day.
Regardless of whether the money is used to pay the school or any other business or institution, these costs are not qualifying educational expenses in the eyes of the IRS:
- Room and Board
- Medical Costs (including student health fees)
- Equipment or Supplies Not Required for a Qualifying Course
- Other Living or Personal Expenses
Similarly, money spent on sports that are not part of credit-earning courses does not qualify. Unless the sport is part of an actual degree plan, any scholarship money spent on it is taxable. The same goes for hobbies, games, or social events.
How do I know if my scholarship is taxable?
To avoid paying taxes on a scholarship, you must be:
- Actively earning a degree and regularly attending classes.
- Attending an educational institution that maintains a regular faculty and curriculum.
- Attending an educational institution that has a regularly enrolled body of students in attendance at the place where educational activities are carried out.
- Using the scholarship money for qualified education expenses.
If you do not fall into these categories, your scholarship may be taxable. If the money is considered payment for services required for receiving the fellowship, then the scholarship or grant would also be considered taxable.
The exception to this is any payment for teaching, conducting research or providing other services under the National Health Service Corps Scholarship Program, the Armed Forces Health Professions Scholarship and Financial Assistance Program, or another eligible student work learning-service program.
How to report a taxable scholarship
If you’re reporting a taxable scholarship — because you received payment for services or because you used the money for a nonqualified expense — you’ll typically receive a W-2 form. You’ll then report the amount listed as taxable income on the “wages, salaries, tips” line of Form 1040.
Even if you don’t receive a W-2, you should still report this income on your taxes. If you don’t have this document, you’ll enter “SCH” and the taxable amount on the dotted line beside the “wages, salaries, tips” line of the 1040 form.
What other education tax credits and deductions exist?
College students have access to special tax credits and deductions while they’re in school or paying off loans. Here’s what you need to know about each program:
- American Opportunity Tax Credit (AOTC): This allows students to claim an annual maximum credit of $2,500 for the first four years of college if they meet the requirements. To get the full credit, they must have a modified adjusted gross income (MAGI) of $80,000 or less ($160,000 or less if married filing jointly). Credits are phased out for MAGIs of $80,000 to $90,000 ($160,000 to $180,000 for joint filers).
- Lifetime learning credit (LLC): This credit allows students to claim 20 percent of the first $10,000 of qualified education expenses per year (with a maximum credit of $2,000). This can apply to students of all levels; undergraduate, graduate, and professional degrees can qualify, with no time restriction. To receive the full credit, borrowers’ MAGI must be below $80,000 for single filers and $160,000 for married filing jointly. The amount is phased out for borrowers with a MAGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers).
- Student loan interest deduction: Students who used student loans to pay for school-related expenses may be eligible to deduct up to $2,500 in student loan interest paid during the previous year. To get the maximum amount, borrowers must have a MAGI below $70,000 for single filers and $145,000 for married filing jointly. Amounts are phased out for borrowers with a MAGI between $70,000 and $85,000 ($145,000 and $175,000 for joint filers).
Your scholarship might be subject to taxes or not. Although some scholarship and fellowship opportunities are not tax-exempt, generally speaking, if you are a degree candidate and the award is used to pay for tuition and required fees, books, supplies, and equipment, it is tax-free. Any sum that is utilized as a living expense stipend or to cover room and board is taxable. Several coordination limitations are also in place to make sure you don’t take advantage of the Education Tax Benefits twice.
1. Are scholarships for online learning programs treated differently for tax purposes?
2. What happens if I use scholarship funds for non-qualified expenses?
If you use scholarship funds for non-qualified expenses such as vacations or a car, that portion of the scholarship may become taxable income.
3. Do college students have to file tax returns?
Attending school is a non-issue when it comes to filing a tax return. The requirement to file depends on how much income you had during the tax year. You must typically file a return if you earned more than the standard deduction for your filing status, but special rules apply to those who can be claimed as dependents on someone else’s tax return.