Scholarships: Understanding the Tax Implications
As tax season unfolds, it’s important for college students and recent graduates to organize their financial documents and understand their potential tax obligations, especially if they have received a scholarship in the past year. While scholarships are often perceived as “free money,” there are specific circumstances that may require reporting scholarships as taxable income.
Some scholarships will have restrictions for what the money can be used for, while others allow for a broader range of uses with the funds, but allowable expenditures are not necessarily the same as qualified education expenses for tax purposes. When scholarships are awarded to a degree-seeking student enrolled at an eligible educational institution they are considered tax-free, but only when the funds are used for qualified educational expenses.
To ensure that a scholarship remains tax-free, students must meet certain conditions:
- They must be a full-time or part-time student seeking a degree at a primary, secondary, or accredited post-secondary institution.
- The scholarship funds must be used to cover expenses directly related to education, such as tuition, fees, books, supplies, and equipment.
A scholarship becomes taxable when it is used for non-qualified expenses such as:
- Room and board
- Travel costs
- Optional equipment
If a student receives a scholarship award that covers both tuition, and room and board, then the portion that’s used for tuition remains tax-free, while the amount used for room and board becomes taxable.
As for college students who aren’t pursuing a degree, all scholarship income is considered taxable – even if the funds are spent on qualified educational expenses. The taxable scholarship income must be reported and included in the total income for the year and is typically reported on the same line as “Wages, Salaries, Tips, etc.” Students should make sure to review the instructions on the tax form to figure out how to report any income from scholarships correctly.
By understanding the tax implications of scholarships, students can avoid unexpected tax liabilities during the tax season. It’s also important to know that the IRS has restrictions set in place to prevent students from taking advantage of any benefits twice when using the education tax benefits.
If students are still uncertain about whether a scholarship award is taxable, they should contact the organization that sponsored the award, as they are likely to have information from the IRS about the award’s tax status and reporting requirements. Additionally, for direct information from the IRS, use the website, helpline (1-800-829-1040), or refer to IRS Publication 970 for information about the tax benefits of education.
Ask Westface College Planning for Help
At Westface College Planning we can help you navigate the college planning process from start to finish. If you need help understanding scholarships or with your college financial planning, reach out to schedule a complimentary consultation today!
Ready for your own success story?
If you’re a typical parent with college-bound students, you’re probably overwhelmed. You want to help your sons and daughters make the right choices and prevent overpaying for their education. You’re not alone! We’re here to help. Schedule your free consultation today – click below to get started!
Catch our free, on-demand webinar:
How to Survive Paying for College
Join Beatrice Schultz, CFP® for our on-demand webinar, where she provides parents with the exact steps that often greatly lower the cost of college, even if there’s little time to prepare.