Generally, scholarships used to pay for qualified educational costs at an eligible educational institution aren’t considered taxable income. The same goes for any grants used to pay for college tuition and fees.
However, there are some cases in which scholarship or grant money may be taxable. For example, if you have money left over after covering your qualified education expenses and use it for other costs (such as room and board or school supplies not required by your program), these funds typically count as taxable income.
If you or your student received scholarship funding, it can be helpful to know ahead if it will contribute to your tax liability. Here’s what you need to know about identifying taxable scholarships and handling filing requirements.
Scholarships That Are Tax-Free
Students can be exempt from paying taxes on their college scholarships if they satisfy certain criteria. For one, they must be enrolled at an accredited college, university, or educational institution that maintains regular attendance.
Additionally, scholarship funds must be used to pay for qualified education expenses — a determination made by the IRS. Under this definition, qualified education expenses include the following:
• Mandatory fees (e.g., athletic and tech fees)
• Equipment and supplies (e.g., lab equipment)
When it comes to textbooks, equipment, and supplies, anything that is required by your school to complete coursework would be free from taxes. If you use the funding towards an extra-curricular activity, such as a club or intramural sport, however, the amount you spend would be considered taxable.
If the scholarship is used for a certificate or non-degree program, the entire amount is taxable whether or not funds are used for qualified education expenses.
It’s important to note that any scholarship funds leftover after paying for qualified education expenses would become taxable income.
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Scholarships Considered Taxable Income
How are scholarships taxable? According to the IRS, scholarships used for expenses outside the scope of qualified education expenses must be reported in gross income — making them taxable.
Scholarship funds used for the following costs are considered taxable by the IRS:
• Room and board
• Medical expenses
• Optional equipment (e.g., new computer)
But are scholarships taxable income in any other situations?
Scholarships that are awarded in exchange for services like teaching or research, often known as fellowships, are classified as taxable compensation in most cases. Students would have to pay taxes even if their fellowship money is used to pay for tuition and other qualified education expenses.
However, there are a few exceptions when education-related payments could be tax-exempt. Specifically, students do not have to pay taxes on funds received for required services through the following scholarship programs:
• National Health Service Corps Scholarship Program
• Armed Forces Health Professions Scholarship and Financial Assistance Program
• Student work-learning-service programs operated by a work college
Other forms of financial aid could be considered taxable income as well.
Earnings through the Federal Work-Study program are subject to federal and state payroll taxes. If you stay below 20 hours a week while enrolled full-time, you won’t have to pay FICA (taxes for Medicare and Social Security) taxes.
Even Pell Grants — a federal aid program for students with significant financial need — are taxable if they’re not used for qualified education expenses.
Making it Legal: Reporting Taxable Awards
If a college scholarship is considered taxable, the student would need to report the scholarship (or portion of the scholarship) on their tax return.
Some students may receive a W-2 form from the scholarship provider outlining the taxable amount. Otherwise, they may need to calculate and enter the amount on their own tax return.
The student would report any taxable amount of a scholarship, grant, or fellowship as follows:
• If filing Form 1040 or Form 1040-SR, you would include the taxable portion in the total amount reported on Line 1a of your tax return. If the taxable amount wasn’t reported on Form W-2, enter it on Line 8 of Schedule 1 (and attach the form).
• If filing Form 1040-NR, you would report the taxable amount on Line 8 and fill out and attach a Schedule 1.
If you have questions about whether or not any portion of your scholarship money is taxable and how to report those funds on your tax return, it’s a good idea to consult a tax professional for personalized guidance.
How Education Tax Credits Fit in
Students and their family members may be eligible to claim the American Opportunity Tax Credit (AOTC) or the Lifetime Learning Credit (LLC) if they paid for college and related costs in the past year. Take note that you can’t use both tax credits for the same student in the same year.
To claim either tax credit, you’ll need Form 1098-T from your college. This form shows any reportable transaction for an enrolled student.
To qualify for the AOTC or LLC, you could have paid educational expenses out of pocket or with student loans. Expenses that were paid for by tax-free scholarships are not eligible for a tax credit.
The AOTC and LLC differ in scope and eligibility, so it’s helpful to compare both to see which may apply and provide a greater tax return.
American Opportunity Tax Credit (AOTC)
The AOTC can be used for qualified education expenses — tuition, fees, textbooks, and necessary supplies — for a student’s first four years of college.
The maximum credit currently stands at $2,500 a year for eligible students. This is calculated as 100% of the first $2,000 in qualified education expenses paid for an eligible student plus 25% of the next $2,000 in qualified education expenses.
If the AOTC reduces your taxes to zero, it’s possible to have 40% of the remaining credit (up to $1,000) refunded.
Eligibility for the AOTC is based on the tax filer’s modified adjusted gross income (MAGI). If you’re filing separately, your MAGI must be $80,000 or less to qualify for the full AOTC credit. The threshold is $160,000 for married filing jointly.
It’s possible to receive a reduced AOTC amount if filing separately with MAGI between $80,000 and $90,000 or $160,000 and $180,000 for married filing jointly.
The Lifetime Learning Credit (LLC)
The LLC can apply to a broader range of expenses than the AOTC. It can be used to claim up to $2,000 for tuition and related educational expenses for undergraduate, graduate, or professional degree courses. Costs of non-degree programs that improve job skills are also eligible for the LLC.
This credit does not have a limit on the number of years it can be claimed on your tax return. However, the LLC has stricter income requirements.
For Tax Year 2022, the amount of your LLC is gradually reduced (phased out) if your MAGI is between $80,000 and $90,000 ($160,000 and $180,000 if you file a joint return).
You can’t claim the credit if your MAGI is $90,000 or more ($180,000 or more if you file a joint return).
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Don’t Forget Deductions
If you’re paying interest on a student loan, you may be eligible to deduct up to $2,500 of that interest with the student loan interest deduction. To be eligible, interest payments must be legally obligated and your filing status can’t be married filing separately.
There are also income requirements, which can vary annually, to factor in for the deduction calculation. For the tax year 2022, the filer’s MAGI must be less than $85,000 (or $170,000 if filing jointly) to be eligible for the full $2,500 deduction.
If your MAGI is between $70,000 and $85,000 (or $140,000 and $170,000 if filing jointly), you could qualify for a reduced deduction.
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Scholarships, grants, and fellowships can help make college more affordable. Not only that, the funds you receive typically aren’t taxable.
A general rule is that your college scholarship is tax-free when it is used to pay for “qualified education expenses.” Exceptions include any part of the scholarship or grant you used to pay for supplemental things (not required for a course) or as payment for work or services you performed.
If scholarships, grants, other aid, and federal student loans are enough to cover the cost of your college education, you may want to consider applying for a private student loan. Loan limits vary by lender, but you can often get up to the total cost of attendance. Interest rates may be fixed or variable and are set by the lender. Generally, borrowers (or cosigners) who have strong credit qualify for the lowest rates.
Keep in mind, though, that private loans may not offer the borrower protections — like income-based repayment plans and deferment or forbearance — that automatically come with federal student loans.
If you’ve exhausted all federal student aid options, no-fee private student loans from SoFi can help you pay for school. The online application process is easy, and you can see rates and terms in just minutes. Repayment plans are flexible, so you can find an option that works for your financial plan and budget.
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