Scholarships are an excellent way for students to finance their college education. But once a student receives a scholarship, do the funds become taxable? Understanding how scholarships work, and most importantly if they are taxable or not can help ease financial worries when it comes to affording college tuition.
Let’s take a brief look at the tax laws governing scholarships, and review some important points about this form of financial aid so that you can make the most out of them and avoid potential tax implications.
In most cases, scholarship money is exempt from taxes as long as the recipient is pursuing a degree at an accredited institution and the funds are applied toward qualified educational expenses.
How Scholarships Are Taxed?
In the United States, scholarships are generally not taxed as income if they meet certain criteria. The Internal Revenue Service (IRS) considers scholarships as tax-free income if they are used exclusively for tuition, fees, books, and other supplies required for courses of study.
However, the IRS requires students to report any scholarship money that is not used solely to cover qualified educational expenses. Usually, this will result in the student having to pay taxes on those scholarship funds.
For example, if a student receives $10,000 in scholarships but only spends $8,000 of it on tuition and fees, they will have to report the remaining $2,000 as income and may be subject to federal and state tax liabilities. In addition, any unlimited amounts of scholarships used to pay for room and board are taxable as well.
See Also: Can Scholarships Pay For Housing
Are Grants Taxable?
Like scholarships, grants are typically given to students to help pay for college expenses. Grants may be provided by the government or other organizations and generally do not need to be repaid. However, any grant money that is used for purposes other than tuition, course fees, books, supplies and equipment required for courses of study will also be taxable.
Taking an example of a student receiving a $5,000 grant from her college for tuition. If that student uses the remaining $3,000 to pay for living expenses such as rent and food, then he or she will be required to report the additional $3,000 as income on their taxes.
Are Fellowships Taxable?
Fellowships are similar to scholarships and grants in that they are usually awarded to students for educational expenses, such as tuition and books. They are typically funded by private foundations, universities, and corporations.
Like scholarships and grants, fellowships do not need to be repaid and any amount used for qualified education expenses is not taxable. However, if the fellowship money is used for other purposes than those related to education or research then it is considered taxable.
My sister-in-law was awarded a fellowship to write her thesis. Unfortunately, she used some of the money for living expenses and had to report them as taxable income on her taxes and pay taxes on the amount.
You can also read the rules of taxable scholarships and fellowships of your state/country so that you can maximize your education savings while staying within the limits of the tax code.
Important Points To Note For Taxes on Scholarships
- Scholarship and fellowship money granted to students primarily for educational expenses is generally not considered taxable income by the Internal Revenue Service (IRS). This includes tuition, fees, books, supplies, and equipment required for the program of instruction.
- Money used for living expenses such as rent, food, clothing, or travel is taxable.
- Scholarships are taxable if the amount received exceeds tuition and fees or when it is received for services such as teaching, research, or other activities conducted by the student in return for the scholarship money.
- Some scholarships may be partially non-taxable, so it’s important to discuss this with your tax advisor.
- If a student receives money from an employer, grants, or other non-scholarship sources, this is usually taxable income.
- Scholarships are not taxable if you are a degree-seeking student and the scholarship does not exceed your qualified educational expenses (tuition and fees).
Also Read: Can Scholarships Pay off Student Loans
Yes, there is an exception if a student receives a scholarship specifically for use in a study abroad program. In this case, the student does not have to report it as income since it would be considered part of their qualified educational expenses.
If the scholarship is given to help a student with their qualified educational expenses (tuition and fees), then it is not taxable. However, any money that goes beyond tuition and fees would be considered taxable income.
Generally, grants are not considered taxable in Canada. If a grant is given specifically for the purpose of research or to defray educational costs, then it is considered nontaxable.
I’m Charlotte Mason From Colorado, I have done Ph.D In Counseling Psychology From University of Denver. Over the years I have been counselling the students worldwide to have a better road map of scholarships and university degree programs. It gives me inner satisfaction when students tell me how they are having a great career after they took counselling from me regarding the degrees.