Scholarships used to pay for tuition and textbooks are generally tax-free, while scholarship amounts used to pay for other college costs, such as housing, meal plans and transportation, are taxable. The student must also be a degree candidate for the scholarships to be excluded from income. The scholarship also cannot be fee for services, with a few exceptions.
When Is a Scholarship Tax-Free?
If a student is a candidate for a degree at an educational organization, then scholarships, grants and fellowships received by the student are excluded from income when they are used to pay for qualified tuition and related expenses.
Qualified tuition and related expenses include
- Tuition and fees required for enrollment or attendance at the educational organization
- Books, supplies and equipment required for courses of instruction at the educational organization
Educational organizations include colleges and universities. An educational organization does not necessarily need to be eligible for Title IV federal student aid.
The scholarship cannot be payment for teaching, research or other services by the student as a condition for receipt of the scholarship. There are exceptions to this “fee for services” restriction for tuition waivers that are provided in connection with graduate student teaching and research assistantships. There are also exceptions for National Health Service Corps Scholarships, Armed Forces Health Professional Scholarships and comprehensive student work-learning-service programs operated by work colleges.
G.I. Bill benefits and other payments for education and training administered by the VA are tax-free. Military scholarships administered by third party organizations are treated the same as other scholarships for determining their tax-free treatment.
What about Tuition Waivers?
Tuition waivers and tuition reductions for employees of an educational organization, the spouse of the employee and the employee’s dependent children are also tax-free, provided that the tuition waiver does not discriminate in favor of highly compensated employees.
Tuition waivers for graduate student teaching and research assistantships are also tax-free.
When Is a Scholarship Taxable?
A scholarship is taxable when any of the following criteria apply:
- The student is not a degree candidate.
- The scholarship is a fee for services, with a few exceptions, such as tuition waivers for graduate student teaching assistantships and research assistantships.
- The part of a scholarship that is used to pay for expenses or restricted to paying for expenses that are not qualified tuition and related expenses is taxable.
The college’s cost of attendance includes several costs that are not qualified tuition and related expenses.
- Room and board
- Dependent-care costs
- Disability-related expenses
- Reasonable study abroad costs (if approved for credit by the student’s home institution)
- Loan fees, including origination fees and guarantee fees
- Professional licensing/certification costs
- Miscellaneous personal expenses
If an educational expense, such as books, supplies and equipment, is not required for enrollment or attendance at the educational organization, it is not considered a qualified tuition and related expense. Likewise, educational expenses that are not part of the cost of attendance, such as travel, research and clerical help, are not considered to be qualified tuition and related expenses.
What about Athletic Scholarships?
An athletic scholarship is like any other scholarship, in that amounts used to pay for tuition and textbooks are tax-free. Amounts used to pay for room and board and other non-qualified expenses, however, are taxable.
Also, for an athletic scholarship to be tax-free, it cannot be a fee for services. According to the IRS, the college can expect, but not require the recipient of an athletic scholarship to participate in a particular sport. For example, if the student is unable to participate in the sport because they are injured, the college must continue the scholarship.
Coordination Restrictions with Other Education Tax Benefits
Although a non-qualified distribution from a 529 plan is penalty-free up to the amount of a tax-free scholarship received during the same tax year, the non-qualified distribution will still represent taxable income to the beneficiary or the recipient of the distribution.
Coordination restrictions prevent the same tuition and textbook expenses from justifying both a tax-free scholarship and an American Opportunity Tax Credit or Lifetime Learning Tax Credit. Different expenses must be used for each tax benefit.
How to Report Taxable Scholarships on Your Tax Return
According to Chapter 1 (Scholarships, Fellowship Grants, Grants and Tuition Reductions) of IRS Publication 970, the taxable portion of a scholarship, grant or fellowship should be included in the total on line 1 (Wages, salaries, tips, etc.) of IRS Form 1040.
If the taxable amount is not reported on IRS Form W-2, write SCH and the taxable amount on the dotted line next to line 1.
Scholarship providers are not required to report the tax-free portion of a scholarship on IRS Form 1099.
(Colleges are required to report scholarships and grants administered and processed by the college for the student on IRS Form 1098-T, Tuition Statement, along with tuition and fees. The Tuition Statement does not list all qualified tuition and related expenses, such as textbooks, supplies and equipment. It also does not list all scholarships and grants.)
Use a scholarship tax calculator to estimate the taxes on a scholarship.