Do scholarships count as income? Are they taxable or tax-free? This article will help you resolve this confusion regarding different scholarships and understand whether they are taxable or tax-free.
In most cases, students studying at a college, university, or other recognized educational institution can avoid paying taxes on at least a portion of their scholarship funds. Generally, you do not have to pay taxes on scholarship money that is used to cover the basic costs of your studies. The IRS calls these “qualified education costs or expenses.”
This means that you are unlikely to need to count these scholarships as income or pay tax on them if your scholarships are used to access courses or for special materials required for your course of study.
How to Find Scholarships That Are Tax-Free and Do Not Count as Income
Scholarships that are not taxable and do not count as income can be found everywhere. Whether a scholarship is taxable or not depends heavily on the type of student you are and how you plan to use the money. However, before determining whether your scholarship is tax-free, you need to know how to look for scholarships in general.
To start your scholarship search, visit scholarship search engines. You will see a list of scholarships you can apply for. These should be scholarships for which you are eligible.
In addition to scholarship search engines, you can ask your guidance counselor or college financial aid administrators about scholarship opportunities. They can provide inside information on tax-free scholarships from local institutions and organizations.
Also Read: How do Scholarships work?
How to Know if Your Scholarship is Tax-Free
There are ways to determine whether a scholarship is tax-free before applying. First, there are general rules for tax-free scholarships and educational items that are not taxable.
In general, a scholarship is tax-free if you are a full-time or part-time candidate for a degree from a recognized university. Scholarships are also considered tax-free if they cover tuition fees, books, supplies, and course materials.
However, some educational expenses are taxable. These include accommodation and meals, travel, research, administrative support and fees, books, and supplies that are not required for your course of study. For example, if you win a scholarship that covers tuition, room, and board, you do not have to pay taxes on the tuition fees, but the room and board are taxable.
Winning a scholarship that is not tax-free should not be seen as a penalty. The taxes you have to pay are minimal, especially considering the amount used to pay for your education. Don’t avoid asking about scholarships that may be taxable and applying for them. Consider any money that you receive to pay for your education as a worthwhile investment.
Also Read: How to get scholarships for Studying Abroad
Scholarships that are Considered Taxable Income
Suppose your daughter is a grad student with a scholarship that requires her to be a teaching assistant. In this case, the tax regulations are different. This is because fellowships or scholarships that provide compensation are considered income and are taxable regardless of how the money is used. Even if a $20,000 fellowship for teaching assistants is used primarily for tuition and books, that $20,000 scholarship or fellowship would still be considered taxable income. The student will receive a W-2 from the academic institution and should file a tax return.
Some Exceptions
These IRS regulations apply to scholarships, grants, and fellowships, including need-based Pell Grants funded by the government. However, there are exceptions.
For example, payments made through the GI Bill are not considered scholarships and do not count as taxable income. Students participating in the Armed Forces Health Professions Scholarship or the National Health Service Corps Scholarship Program and Financial Assistance Program generally do not pay taxes on their financial support for eligible educational expenditures. Student loans are, of course, never taxable as they are not scholarships, are not considered income, and must be paid back.
To be very clear, scholarships awarded to students who are not participating in a study program are always taxable.
Also Read: Expert scholarship advice
How to register tax credits for education
Education tax credits that reduce the amount of income tax you pay directly could be another way to offset a part of your child’s eligible university expenses based on her own income. There are two possible credits:
American Opportunity Tax Credit (AOTC)
This credit offers a maximum yearly credit of $2,500 per student for four years of college. To be eligible for the full credit, your modified adjusted gross income (MAGI) must be $80,000 or less ($160,000 or less for joint marriage declarations). The tax credit is phased out for taxpayers whose income is above these levels.
Lifelong Learning Credit (LLC)
Lifelong Learning Credit (LLC)
This credit offers a maximum of $2,000 each year per tax return, not per student. It can be used for undergraduate studies, graduate studies, or professional courses with no limitation on the number of years. Income limits are lower: in 2019, the MAGI for individuals must be $68,000 or less ($136,000 or less for joint marriage declarations).
If you are eligible for both credits, you must choose one or the other. You cannot use both.
Can I Use Scholarship Money to Pay Off Loans?
Most scholarships that count as income have a specific purpose, including tax-free scholarships. You usually can’t use the money for any other reason. Therefore, you cannot convert them into cash to repay your student loans. However, you may be eligible for student loan forgiveness and can use this program to repay your loan.
How to Win a Tax-Free Scholarship
You can strategically search for scholarships that do not count as income and are tax-free. First, seek financial aid that covers tax-free education costs such as tuition, fees, and supplies. This ensures that your scholarship is not taxable. Additionally, when applying for a scholarship, it is always acceptable to contact scholarship providers to ask questions such as: “Is this scholarship tax-free?” The more you know about your application, the better you can plan and allocate money if you win.
Second, act strategically when looking for scholarships as a whole. Winning scholarships is a numbers game: the more you apply, the better your chances of winning.
Don’t just apply for large scholarships that may or may not count as income, where you are simply asked to provide your contact details. Use part of your time to apply for smaller scholarships, including local grants. The pool of these awards is usually smaller, which increases your chances of winning.
When it comes to non-taxable scholarships, don’t be afraid of applications that may require a little more work. Scholarships with essay requirements or letters of recommendation often have smaller applicant pools. Sometimes hard work literally pays off!
