Given the rising costs of college, many students seek out scholarships to help ease the financial burden. There are a number of private and federal grants available for college, but whether or not a scholarship is taxable depends on how the money is used. While an academic or athletic scholarship used to pay tuition typically won't be taxable, scholarship money applied to room and board is generally considered taxable income, in which case the IRS will want its share.
Scholarships and taxes
Many scholarships allow you to use the money for any expenses relating to education. But in order for a scholarship to be tax-free, the recipient must be pursuing a degree at an accredited university or institution, and the money from the scholarship must be used for qualified education expenses. These include:
- Equipment needed for studies, such as laboratory materials for a chemistry student
While scholarships applied to the above-listed expenses aren't subject to federal income tax, scholarship money that's used for non-qualifying expenses will typically be taxed. Non-qualified expenses include room and board, travel, and dorm room supplies. If you receive a $10,000 scholarship and that money goes directly toward tuition, it won't be taxed. But if that $10,000 goes toward paying for a dorm, it will be taxed.
Some institutions offer scholarships in the form of fellowships, in which case the tax rules are different. Fellowships often grant students a certain amount of money in exchange for a specific service, and when that happens, the scholarship money itself is taxable. For example, if you're a graduate student and get a $15,000 fellowship requiring you to be a teaching assistant, the IRS would consider that $15,000 to be taxable income -- even if the money is actually used to pay for qualified expenses like grad school tuition.
Exceptions to the rule
While the above rules apply to both academic and athletic scholarships as well as private and federal grants, there are certain exceptions. Payments made through the GI Bill are not considered scholarships and aren't subject to taxes. Furthermore, students who participate in the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program also aren't required to pay taxes on the scholarship money they receive.
Qualified tuition reduction
Qualified tuition reduction programs allow active and retired employees, as well as their spouses and dependents, to enroll in studies at a discount. This discounted tuition, however, is not considered taxable. So if you receive a $10,000 qualified tuition reduction at an eligible educational institution, that money does not have to be included as income on your tax return.
Paying taxes on scholarships
Though you typically don't need to pay taxes on scholarships up front, you do need to report taxable scholarships on your return and pay the IRS accordingly. Be on the lookout for a 1099 form in the mail summarizing the amount of scholarship money you received, and be sure to include this information when you file your taxes. Failing to do so could result in unwanted penalties -- and as a student with enough on your plate, that's a whole world of stress you don't want to dabble in.