Are Scholarships Taxable?
Scholarships, fellowships and grants are tax-free to the extent that they are used to pay for qualified higher education expenses if the student is a candidate for a degree and the money does not represent a fee for services.
The tax-free status of scholarships, fellowships and grants is implemented by not reporting the money as taxable income. The IRS has special procedures for taxpayers to report the taxable portion of scholarships, fellowships and grants.
Scholarships, fellowships and grants are exempt from FICA taxes, including Social Security and Medicare taxes, regardless of whether the student is a degree candidate or the money is used for qualified higher education expenses.
Qualified higher education expenses include tuition, fees and course materials (required textbooks, supplies and equipment).
A qualified tuition reduction for the undergraduate education of college and university employees is eligible for the income exclusion provided that it does not discriminate in favor of highly compensated employees. There is a similar exclusion from income for full or partial tuition waivers provided to graduate student teaching and research assistants.
If a scholarship, fellowship or grant is used or required to be used to pay for living expenses, such as room and board or transportation to/from college, the money must be reported as taxable income to the student.
If a scholarship, fellowship or grant represents a fee for teaching, research or other services, it must be reported as taxable income. There is an exception for tuition waivers and reductions for teaching and research assistantships. The stipend portion of an assistantship represents taxable income even if used to pay for tuition. There also is an exception for some health profession scholarships, such as the National Health Service Corps Scholarship and the Armed Forces Health Professions Scholarship.
There is no requirement that the college or university be accredited or that it be eligible for Title IV federal student aid.
The exclusion from income for scholarships, fellowships and grants is available for an unlimited number of years and does not expire.
There are no income phase-outs on the exclusion from income for scholarships, fellowships and grants. The exclusion from income is available regardless of the student’s tax-filing status. Even married taxpayers who file separate returns are eligible.
Coordination restrictions prevent double-dipping. You cannot use the same expenses to justify both the exclusion from income for the tax-free portion of a scholarship, fellowship or grant and another education tax benefit, such as a tax credit or a tax-free distribution from a 529 college savings plan. Thus, you cannot use a tax-free scholarship to pay for tuition and fee expenses that are used to claim the American Opportunity Tax Credit. Each education tax benefit must be based on different expenses.
How to Report Taxable Scholarships, Fellowships and Grants
The tax-free portion of a scholarship, fellowship or grant is not reported on the student’s federal income tax return.
If the taxable portion of a scholarship, fellowship or grant is not reported to the IRS on a W-2, the IRS has special procedures for reporting it on the student’s federal income tax return.
The taxable portion of a scholarship, fellowship or grant should be included in the line for “Wages, salaries, tips, etc.” on the student’s federal income tax return. This is on the following lines for each type of federal income tax return:
- IRS Form 1040: Line 7
- IRS Form 1040A: Line 7
- IRS Form 1040EZ: Line 1
- IRS Form 1040NR: Line 12
- IRS Form 1040NR-EZ: Line 5
If the taxable portion of the scholarship, fellowship or grant is not reported to the IRS on a W-2, write “SCH” and the taxable amount in the space to the left of the line item on the tax return.
Scholarships, fellowships and grants are reported on a W-2 only if they represent payment for teaching, research or other activities. Scholarship providers are not required to issue 1099s.
Qualified higher education expenses, such as tuition and fees, may be found on IRS Form 1098-T, Tuition Statement.
A good source of additional information is Chapter 1 of IRS Publication 970, Tax Benefits for Education. The statutory language appears in the Internal Revenue Code at 26 USC 117. The current regulations can be found at 26 CFR 1.117-1, 26 CFR 1.117-2, 26 CFR 1.117-3, 26 CFR 1.117-4, 26 CFR 1.117-5 and 26 CFR 1.6041-3.