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Earning a scholarship is a significant achievement and can be one of the best ways to lower the cost of college. Most scholarships are not considered taxable income, so that free money shouldn’t affect you come tax season. However, it’s important to be aware of when scholarships, grants and fellowships can impact your tax returns.
To not be taxed, you generally must use the scholarship for attending school and use the money for direct education purposes like tuition, student fees or class books. Uses outside of those situations tend to make the scholarship into taxable income. Below you can learn more in-depth about when scholarships might be taxed.
Is scholarship money considered income?
Whether or not scholarship money is considered taxable income is based on how you use the funds. In general, it’s best to confirm a scholarship’s tax status with a financial advisor or certified tax professional.
Ashley Boucher, manager of corporate communications at Sallie Mae, says that a general rule of thumb is that scholarships are not considered taxable if the money is used to pay for qualified education expenses. These expenses include tuition, student fees and textbooks.
There are a few circumstances where scholarships could be considered taxable income. “An example would be if scholarship money was used to pay for rent, board, utilities or other school supplies not listed in your syllabus,” says Boucher.
How do I know if my scholarship is taxable?
To avoid paying taxes on a scholarship, you must be:
- Actively earning a degree and regularly attending classes.
- Attending an educational institution that maintains a regular faculty and curriculum.
- Attending an educational institution that has a regularly enrolled body of students in attendance at the place where educational activities are carried out.
- Using the scholarship money for qualified education expenses.
If you do not fall into these categories, your scholarship may be taxable. If the money is considered payment for services required for receiving the fellowship, then the scholarship or grant would also be considered taxable.
The exception to this is any payment for teaching, conducting research or providing other services under the National Health Service Corps Scholarship Program, the Armed Forces Health Professions Scholarship and Financial Assistance Program or another eligible student work learning-service program.
How to report a taxable scholarship
If you’re reporting a taxable scholarship — because you received payment for services or because you used the money for a nonqualified expense — you’ll typically receive a W-2 form. You’ll then report the amount listed as taxable income on the “wages, salaries, tips” line of Form 1040.
Even if you don’t receive a W-2, you should still report this income on your taxes. If you don’t have this document, you’ll enter “SCH” and the taxable amount on the dotted line beside the “wages, salaries, tips” line of the 1040 form.
What other education tax credits and deductions exist?
College students have access to special tax credits and deductions while they’re in school or paying off loans. Here’s what you need to know about each program:
- American opportunity tax credit (AOTC): This allows students to claim an annual maximum credit of $2,500 for the first four years of college if they meet the requirements. To get the full credit, they must have a modified adjusted gross income (MAGI) of $80,000 or less ($160,000 or less if married filing jointly). Credits are phased out for MAGIs of $80,000 to $90,000 ($160,000 to $180,000 for joint filers).
- Lifetime learning credit (LLC): This credit allows students to claim 20 percent of the first $10,000 of qualified education expenses per year (with a maximum credit of $2,000). This can apply to students of all levels; undergraduate, graduate and professional degrees can qualify, with no time restriction. To receive the full credit, borrowers’ MAGI must be below $80,000 for single filers and $160,000 for married filing jointly. The amount is phased out for borrowers with a MAGI between $80,000 and $90,000 ($160,000 and $180,000 for joint filers).
- Student loan interest deduction: Students who used student loans to pay for school-related expenses may be eligible to deduct up to $2,500 in student loan interest paid during the previous year. To get the maximum amount, borrowers must have a MAGI below $70,000 for single filers and $145,000 for married filing jointly. Amounts are phased out for borrowers with a MAGI between $70,000 and $85,000 ($145,000 and $175,000 for joint filers).
The bottom line
As long as you are using the scholarships for their intended purpose of tuition, school fees or textbooks at a legitimate educational institution, scholarships are not taxed. You might run into situations of your scholarship turning into taxable income if you use it for other purposes like rent. Whether you find your scholarship is taxable or not, you might look into education tax credits or deductions to help you.