College can be a very exciting time for you and your dependents, but can also cause stress and confusion about tax consequences related to scholarships and education expenses. Many people know that there are tax benefits and credits for paying tuition, but some may not know that there also may be taxable consequences for receiving good grades. Keep reading to find out what hidden tax consequences may be lurking.
Generally, scholarships (or fellowship grants) are free from federal tax as long as they are for a student’s tuition. However, if the scholarship is for tuition and for other expenses, such as room and board, only the portion of the scholarship that applies to tuition is free from tax. You must determine what percentage of the scholarship applies to tuition and what percentage applies to other expenses. Books, fees, and supplies are included in the IRS’s definition of tuition, so any scholarship proceeds that can be applied to these expenses are tax-free. On the other hand, a scholarship may also be used for expenses that are taxable including: room and board, travel, research, non-required equipment and other expenses that are not required for either enrollment or attendance.
Sometimes it is difficult to determine if a fee or expense can be considered a qualified tuition or a related expense. The general rule to determine if a cost is part of qualified tuition, or a related expense, is whether the fee is required to be paid to the eligible education institution for enrollment or attendance. If the fee is optional, or provides a benefit above and beyond what is required, that expense is no longer considered required and therefore not qualified.
Scholarships need not be only for college or university tuition. The same rules govern elementary, high school, and vocational school scholarships. Athletic scholarships also generally qualify for this favorable tax treatment as long as the value of the scholarship does not exceed certain amounts.
Teaching and research stipends, which serve as particularly common ways to lower graduate school expenses, generally do not qualify as scholarships. They must be reported as income, and they are subject to federal tax if they are required as a condition to receiving the qualified scholarship or qualified tuition reduction.
If you have any questions regarding taxability of scholarships or any issues associated with education expenses, please do not hesitate to call your L&B professional at (858) 558-9200.