If you've received a scholarship for college, you might be wondering if you need to include it in your taxes or if it's taxable income. This guide will help you know all the details!
Getting a scholarship for school can be exciting and take many of the stresses away of needing to pay for tuition. However, many people wonder if these scholarships they receive are taxable and what they should do when tax season rolls around.
In most cases, scholarship money is tax-free. You have to be a candidate at an eligible institution, though, and the money has to be used on qualified expenses. There are some instances where scholarship money is not tax-free.
Since you are new to scholarships, you are probably confused about what you can spend the money on and if you need to include any of this on taxes. We will cover all the details in this article as well as give a few instances when scholarships are considered taxable income.
Are Scholarships Tax-Free?
In most cases, yes! However, the scholarship needs to meet certain criteria from the IRS to be considered tax-free. For starters, you have to be a degree candidate at an eligible educational institution.
This usually just means you need to be attending a college or university where there is regular faculty, enrolled students, and a curriculum. You also need to make sure the money you have received is being used for qualified expenses only. This can include tuition fees, books, supplies, and equipment for classes.
Qualified expenses do not include anything related to room and board, even if they are being used to pay for your dorm room. They also shouldn't be used to pay for travel, even if it's for things like gas to and from school.
The scholarship money also cannot be used as part of your wages, such as money you might receive from being a teaching assistant or something similar.
This sounds pretty straightforward, but some people aren't sure what they can and cannot use the money for. What makes it more confusing is that some scholarships are put right into your bank account rather than being paid to the school. This basically gives you the freedom to use the money for whatever you want.
Let's say you receive a $20,000 scholarship and spend $17,000 on things like tuition, fees, and class books. You spend the other $3,000 on dorm room furniture. The last $3,000 would be considered taxable income because you did not spend it on things that were directly related to a class or a program.
This is confusing for many people because they think buying things for their dorm room would be an education expense since the dorm is on campus.
Also, many people decide to pay for third-party scholarships from websites rather than applying for scholarships from education organizations or foundations. This money is usually put right into your bank account, and some of these places don't even check what you used the money on.
If you decide not to attend college or use the money for rent or travel, it should be included as part of your taxable income.
Does The IRS Check What I Spent the Money On?
This can be a risky question. Many students spend their scholarship money on things unrelated to school and then when the IRS does not check where the money went, they think it's okay to keep doing it. While scholarships, especially small ones, are unlikely to be audited by the IRS, you should still be careful to only use the money on education expenses to avoid getting into trouble.
All money that was used for things, not education-related should be written down and then included as part of your taxable income so that your tax returns are honest.
Scholarships That Are Not Taxable
Unfortunately, there are some types of scholarships and awards where the entire thing is considered taxable. The main example comes from grad students who are offered a fellowship where they are teaching assistants and given a small salary.
Since this scholarship comes in the form of wages (work in exchange for money), the money is taxable. If you have this type of arrangement, you will even get a W-2 from the school showing your income, and you will need to file a tax return.
There are a few other times where your scholarship is taxable. However, most scholarships are not taxable as long as they fit the rules we outlined above.
If you or someone closely related to you served in the military, you might be eligible for the GI Bill. If you receive money after leaving the military or while still in the armed forces through the GI Bill, it's not considered a scholarship.
GI Bill money is also not considered taxable income. So, all this money can go towards you and your education without you needing to worry about paying taxes on it.
Most education-related awards given by the military are not considered taxable income, including The National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship.
The Financial Assistance Program for veterans is also not taxable income. You still need to spend the money on qualified educational expenses, though.
Any type of loan money you receive, whether it be federal or private, is also not taxable income. This is because they are not considered income and will need to be repaid once your education is complete or once you stop attending classes.
Student loan forgiveness is considered taxable income though, but that is a whole different topic. If you receive student loans, you can use them on education expenses. Many people also choose to spend their loans on things like rent or transportation when necessary. Since they are loans and have to be paid back, you can use them for things not related to education.
What About Tax Education Credits?
There are also tax education credits that you might be wondering about if you have received one. Tax credits are available depending on your income. Here are two of the most popular ones received and how they fit into the question of taxable income.
American Opportunity Tax Credit
This credit gives credit of up to $2500 per student for four years of undergraduate education only. You have to have a modified adjusted gross income of less than $80,000 or $160,000 if you are married and filing jointly.
If you make more than this, you might qualify for a smaller credit and not the full $2,500.
Lifetime Learning Credit
This gives a maximum of $2,000 per year per tax return, not per student. It can be used for more than just undergraduate courses, including graduate programs and professional degree courses. You can also use it for more than four years, unlike the American Opportunity Tax Credit.
The income is the same for the American Opportunity Tax Credit and is phased out with the more money you make. This means you might be able to get a smaller credit but not the maximum amount.
If you are able to get both credits, you have to choose one or the other. You are not allowed to use both at the same time. You also cannot use both tax credits on the same student in the same year.
This applies to parents who filed for their students using their tax returns. Both these credits are not considered taxable income as long as you use them for qualified education expenses.
What Can I Use Scholarship Money For?
This is the most important thing when it comes to avoiding taxes on scholarships. You need to use as much of the money as possible on education expenses. The line can become blurry, though. Here are some examples of education-related expenses:
- Any fees added to tuition
- Books from the campus bookstore or another retailer
- New computer that is needed for school and used for school
- Clothing and equipment needed for science lab classes
Expenses not related to education:
- Dorm fees
- Transportation, even if it's to and from school
As you can probably tell by now, most scholarships and grants are not taxable. Loans are also not taxable. If you receive money from a GI Bill or military grants, these are also not taxable. The only catch is that you have to use the money for education-related expenses. Any portion of the money used for personal uses is taxable and needs to be included on your tax return.
Scholarships are also only not taxable if you are in a degree program. If you are in a program that only awards certificates or diplomas, then the money is taxable. If you have any questions, you can always ask your financial advisor at school or an accountant for some help when it comes time to file your taxes.
Shawn Manaher is a former financial advisor, has founded 5 online businesses, and is a coach, speaker, podcast host, and author. He's been featured on Forbes, The Consults Corner on TAE Radio, The Writing Biz, What's Your Story, and more.