College Scholarships and Awards: Looking at Tax Issues
Whenever your student receives any money in the form of a scholarship, a fellowship, or an outright grant, you need to determine whether some, or all, of that money is subject to income tax, payable by the student. If the money that the student receives is in the form of a loan, there are no tax consequences upfront, although as the loan is being repaid, some of the interest may be tax-deductible.
Financial aid officers are generally a pretty savvy group of people who have a great knowledge of tax issues surrounding students, but they may not have much idea of your personal circumstances. If your student receives a financial aid award that creates tax problems for you or for your student, don't hesitate to contact the financial aid office and try to reformulate the terms of the award to either minimize or totally eliminate the tax implications. Although it's best to make any changes before any money changes hands, you may still be able to change the terms of the award as long as payments remain to be made.
Figuring Out What's Taxable And What's Not
According to the IRS, the following requirements must be met in order for the scholarship money not to be taxed:
- The student must be a degree candidate at an educational institution that maintains a regular faculty and curriculum and has a regularly enrolled student body in a place where it carries on its activities. In other words, your student may attend a primary, secondary, or postsecondary school, and whether or not she ever receives her degree, she has to be working towards one. Scholarships for continuing education courses that don't lead to a degree won't qualify here; neither will fees that you pay to audit a course.
- The scholarship or fellowship payment may not be considered as payment for services performed. Money received for a research or teaching assistantship generally is taxable, but money received as tuition reduction is not.
- The money has to go toward tuition and/or required fees and expenses. The student has to pay tax on all other funds that are used to pay for room and board and other living expenses. The fact that the organization granting the scholarship may not make this breakdown for you doesn't mean that you don't have to — you do. It's your responsibility to keep track of both your expenses and the resources used to pay for them.
The table, based on IRS Publication 520, shows how the IRS breaks down what's taxable and what isn't:
|Payment for||Degree Candidate||Non-degree Candidate|
Table: Tax Treatment of Scholarship and Fellowship Payments
Amounts received to cover tuition, fees, books, supplies, and equipment are nontaxable only if those expenses are required of all students in that course. For example, suppose that your student chooses to buy a computer that isn't required but that makes his life easier and allows him to achieve better results than he would have without the computer. Even if your student receives an A when he might otherwise have received a B, he still has to declare the funds used to buy the computer on his income tax returns, and pay any tax due.
As you know, all rules have exceptions. Most scholarships and fellowships can be broken down into their taxable and nontaxable components fairly easily by using the table, but here are some special situations:
- Veterans' benefits, including any money that you receive through laws administered by the Department of Veterans Affairs, whether or not that money is used to pay for required tuition and fees or for living expenses, is tax-free.
- All amounts received under the National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship and Financial Assistance Program are tax-free even if you use a portion of that money to pay living expenses.
- Qualified tuition reduction programs for graduate students that are provided in exchange for teaching or research are tax-free if the value of the fellowship is used to offset tuition charges. In other words, the student here is teaching or doing research in exchange for tuition, not in exchange for a living-expense stipend.