Are Scholarships Federally Taxed?

Determining how scholarships, fellowships and educational grants are taxed

If you recentlybankingon_e_a003070905 received a scholarship to attend school, the news likely brought a lot of joy with it. It may also have brought some questions, like will you need to report the money as income and pay federal taxes on it? The following information can help you clear up the confusion.

First, it’s important to know that, in general, state and federal educational grants are lumped together with scholarships and fellowships for tax purposes. Whether or not you owe federal taxes on a sum received from one of these sources depends on what type of education you’re pursuing and what the money is used for.

So when is it tax-free?
“Here’s the easy rule: a scholarship, fellowship or grant is tax free only if you are pursuing a degree at an eligible educational institution and you use the scholarship or fellowship to pay qualified education expenses,” states Kelly Phillips Erb, Forbes contributor. “If you are not pursuing a degree, the full amount is subject to tax.”

If the scholarship you receive was won in a contest, it will be taxed unless there is some other reason why you have tax-exempt status for it. Similarly, athletic scholarships are also subject to taxes.

The money you use to pay for tuition and things needed for your courses, such as books will not be taxed. Other expenses that are not taxed include certain supplies needed for class and items that the school requires students to purchase.

“Money for anything else not required for enrollment, including housing and travel, is taxed as income,” states Kimberly Lankford from Kiplinger.com. “And any scholarship money received as payment for services, such as teaching or assisting in a lab, may be taxed.”

There are a few cases when certain scholarship or fellowship money that is received in payment for services will not be taxed.

“Exceptions apply if you receive funds under the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program,” states Phillips Erb. “Additionally, payments you receive for education, training, or subsistence under any law administered by the Department of Veterans Affairs (VA) are tax free.”

Although you may be disappointed to learn that what you thought was free money does come with some tax strings attached, there is a silver lining. When scholarships are taxed, it’s typically at the student’s rate and not at the higher rate of the parents.

If you don’t owe federal income taxes on your scholarship, and you have no other income, you won’t need to send in a federal income tax return. However, you will likely need to report any taxable portion of your scholarship. It can be confusing to determine exactly which portion is taxable, which is why speaking to a tax professional is advisable.

Furthermore, keeping good records is necessary because schools don’t always have to issue W-2 forms.

“And remember: no double-dipping,” cautions Phillips Erb. “You can’t exclude fellowships and scholarships from income and then deduct them as educational expenses.”

Used with Permission. Published by IMN Bank Adviser Includes copyrighted material of IMakeNews, Inc. and its suppliers.

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