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The Taxable Part of Scholarships: What You Must Know

by | Sep 4, 2023 | schlolarship guide | 0 comments

While many see scholarships and financial aid as a one-way ticket to alleviate the financial burden of college, what often slips through the cracks is the tax implications associated with these funds. Knowing how scholarships and financial aid interact with your tax situation can save you from unexpected headaches down the line.

Do You Have to File a Tax Return?

Students and parents often assume that scholarship recipients are not required to file tax returns. However, if a student’s taxable income, including portions of their scholarship, exceeds $12,950, a tax return is necessary—even if they are claimed as a dependent. Even if your income falls below this threshold, filing could yield a refund or qualify you for the Earned Income Tax Credit. It’s essential to understand the nuances so you don’t miss out on any benefits.

What Makes a Scholarship Taxable?

Not all scholarships are created equal, at least not when Uncle Sam is concerned. As long as you’re enrolled in an accredited institution and use the scholarship for qualified expenses like tuition, fees, books, and mandatory supplies, your scholarship remains tax-free.

However, scholarships become taxable income when used for:

  • Room and board
  • Travel expenses, including study abroad
  • Research costs
  • Tutoring or clerical help
  • Any supplies not explicitly required by your program

The dividing line often depends on the percentage of the scholarship used for tuition versus non-qualified expenses. For instance, if 70% of your scholarship is applied to tuition and the remaining 30% for room and board, only the latter portion would be subject to taxation.

What About Emergency Grants and Relief Funds?

Emergency grants or relief funds provided by educational institutions generally follow the same tax rules as scholarships. However, funds received due to a federally declared state of emergency are an exception; they are not considered taxable income.

Student Loan Repayments and Forgiveness

As of the current legislation, student loans forgiven by December 31, 2025, will not be taxed. This benefit extends to employer-provided loan repayment assistance, with the previous cap of $5,250 being lifted until the same date.

Taxing Postgraduate Stipends and Fellowships

While graduate student scholarships follow similar tax rules, teaching stipends and fellowships can be a grey area. For example, if a $5,000 scholarship includes $1,500 for teaching services, that $1,500 becomes taxable income. Make sure to consult your financial aid office to understand how your funding is structured.

Reporting Scholarships on Taxes and Education Tax Credits

Form 1098-T plays a crucial role in reporting scholarships and grants for tax purposes. This form details how much was paid for qualified expenses and how much was received in scholarships or grants. Furthermore, even with scholarships, you might still qualify for tax credits like the Lifetime Learning Credit and the American Opportunity Tax Credit, which can offset costs not covered by scholarship money.

Takeaway: Plan Ahead

Besides staying informed, consider other strategies like deferring your scholarships to a year when your income might be lower or investing in a 529 college savings plan to mitigate tax burdens. Being proactive can save you from unpleasant surprises and keep your education as affordable as possible.

While tax laws and regulations are subject to change, being knowledgeable about current rules can help you make informed decisions. Always consult your financial aid office or a tax advisor for the most up-to-date information and tailored advice.