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Anyone who has ever won a scholarship knows the feeling of pure joy you get when you’re told that a person, company, or organization wants to help make your dreams come true by financing all or a portion of your education. Not only are you incredibly grateful that a group of strangers have chosen to help you, but you also feel extremely relieved knowing that you won’t have to struggle so hard that term or year to pay for all your college costs. You could even be able to ditch the part-time job you hate slinging burgers and focus on your studies!
But come tax time, you might wonder what impact those scholarships will have and whether you’ll end up owing Uncle Sam. Whether or not scholarships are taxable depends on a number of different factors including what you got the scholarship for and what you paid for with the scholarship.
Here’s a quick guide to figuring out whether scholarships are taxable or whether you can keep all that precious cash to yourself.
When Scholarships are Tax-Free
Scholarships are not considered taxable income when they’re used to pay for educational expenses like tuition, fees, and any required books, supplies, or equipment. In order to qualify for this tax exemption, you must be a candidate for a degree at an educational institution that the IRS considers ‘eligible’ – which means that it has a faculty, curriculum and a regularly enrolled body of students.
If you win more scholarships than you owe in eligible expenses, then your part of your scholarships will likely be taxable. There is an exception for payouts that you receive under the G.I. Bill, and scholarships or fellowship that you get through the National Health Services Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program which are never taxed.
When Scholarships are Taxable
When you use a scholarship to pay for expenses that are not considered tax-free educational expenses then you’ll be required to pay taxes on that money. Some of the expenses that are not considered tax-free include room, board, incidentals, travel, and books and supplies not required by your program.
That means that part of any scholarship that you receive could potentially be taxable while another part could be tax-free. For example, if you get a $10,000 scholarship and since you only have $3,000 left to pay in tuition you use the other $7,000 to pay for your room and board, then you will be taxed on that $7,000.
Also, if you’re getting money as wages for teaching or other work, it doesn’t matter whether it’s called the fellowship or scholarship – it will be considered taxable income. In addition, any scholarships that you get when you’re student, but you’re not enrolled in a degree program will always be taxable.
What to Do if You Have Taxable Scholarships
If you discover you have a taxable scholarship, you might not have to fork over that large of a chunk at tax time. There are a number of ways to offset that income. One way is through education tax credits.
There are two different kinds of education tax credits that you can use to potentially offset the taxable scholarships. The first is the American Opportunity Tax Credit. This credit allows you to claim up to a maximum credit amount of $2,500 per student for four years of undergraduate education. There are income requirements in order to qualify, but most students will not be making more than the cut-off of a modified adjusted gross income of $90,000 for a single filer or $180,000 married joint filers. If you are, that’s a really great job flipping burgers!
The other tax credit is the Lifetime Learning Credit which allows you to claim a credit up to a maximum of $2,000 per tax return for an unlimited number of undergraduate, graduate, or professional degree courses. The limit for this credit is a modified adjusted gross income of $65,000 or $131,000 for married joint filers.
On top of these tax credits, there are also deductions that you can use to offset taxable scholarship income. You can deduct college expenses of up to $4,000 per year for yourself or any dependents.
Want More Info?
Make sure to read through the IRS report on educational tax benefits, or better yet – get an accountant to advise you so that you can spend your time studying instead.
Author: Jeff Gitlen, CEPF®