Scholarships are one of the best ways to pay for college. With both merit-based and need-based scholarships available through states, colleges, universities, professional schools, nonprofits, and for-profit organizations, there are many options to help you pay for school and keep your student loans as low as possible.
Scholarships are considered “free” money because you do not have to pay them back. While student loans must be repaid over ten or more years — and accrue interest — scholarships offer a few hundred to several thousand dollars every year, covering essential aspects of your education like tuition, fees, books, and living expenses with no commitment to repay.
But are scholarships taxable? Many forms of financial aid for students involve some regulations from the Internal Revenue Service (IRS), meaning you can either claim the money as a deduction or credit on your taxes, or it is considered taxable income.
However, scholarship money is only considered taxable income in some cases.
When Scholarships Are Not Taxable
For the most part, scholarships are not considered income, so you do not have to claim them on your taxes for that year.
Scholarship money is not taxable when:
- You use the money to pursue a degree at an educational institution deemed eligible by the IRS. These are schools offering post-secondary education like colleges, universities, trade schools, or related institutions eligible per the Department of Education’s guidelines. Eligible institutions must:
- Engage in formal instruction.
- Have accreditations and credentials.
- Have regular faculty and curriculum.
- Have an enrolled student body attending the facility where instruction occurs.
- The money covers qualified educational expenses, including:
- Enrollment fees.
- Supplies and equipment for registered courses.
- The scholarship money does not exceed the amount needed to pay for qualified educational expenses.
- The scholarship excludes specific expenses that are not considered qualified educational expenses. For example, the scholarship does not cover housing.
- The scholarship is not a payment in exchange for work like teaching, research, or similar services.
If you receive money from a scholarship program that does not meet the above criteria, you may need to file it as taxable income during tax season.
When Scholarships Are Taxable Per the Law
There are some cases when scholarships are taxable. Understanding the IRS rules about taxes and scholarships will help you avoid potential issues and understand how to best manage the money you receive for your post-secondary education.
Scholarship money is taxable when:
- You receive more scholarship money than you need. Some students are awarded scholarships that pay for their entire education, with some money left over. In this situation, most students use the extra scholarship money for nonqualified expenses, like transportation, on-campus or off-campus housing costs, and food. But anything you receive beyond tuition, related fees, and supplies for your classes will count as income, and you must claim it on a tax return.
It is important to note that you do not have to claim the entirety of your scholarship in some cases. For example, if you receive a substantial award that covers qualified educational expenses, and there is some money left, you only need to claim the extra money. For example, if you receive a $10,000 scholarship, and you have $1,000 remaining after paying tuition and other fees, you only need to claim the remaining $1,000.
- Your scholarship has job-related qualifications. Some scholarships may have specific requirements once you accept the money, like completing a certain amount of teaching or research hours. According to the IRS, this means the scholarship is not free money, but taxable income. Even if the amount you receive only covers tuition and does not cover living expenses, you must still claim it on your taxes.
The IRS lists exceptions to this rule, including:
- The National Health Service Corps Scholarship Program.
- The Armed Forces Health Professions Scholarship and Financial Assistance Program.
- A comprehensive student work-learning-service program operated by a work college (defined in section 448(e) of the Higher Education Act of 1965).
Graduate student scholarships, grants, and fellowships are subject to income tax restrictions as these awards specify job requirements. Although these requirements are associated with your degree and can help you build your career skills, you are still receiving money for work rather than entirely for free.
- Your scholarship is designed to cover nonqualified expenses. There are hundreds of small scholarships, ranging from a few hundred to a few thousand dollars, but many of these are earmarked for particular educational purposes. Some of these purposes are qualified educational expenses, while others are considered taxable income.
For instance, if you receive a $1,000 scholarship for a laptop for class, this is a qualified expense; however, if you receive $1,000 to pay for on-campus housing, this is subject to taxes. If you do not use your scholarship for the specified purpose, you are violating the terms and may be subject to other penalties, including having to repay the money.
- Your scholarship covers classes not related to your degree, or your school is not eligible. Some schools claim they are institutes of higher learning, but they are not accredited. If you receive a scholarship and use it to attend a school that has not received appropriate accreditation to give out degrees, then your scholarship money will be considered taxable income.
Some current students attend an accredited school but are not pursuing a specific degree program, like a bachelor’s or master’s degree. If you are auditing classes or pursuing a non-degree certificate program, any money you receive from a scholarship to pay for these classes will be considered taxable income.
Some Types of Financial Aid Are Not Taxable Income
Some forms of financial aid may lead to tax deductions or exclusions. As mentioned, scholarships that strictly cover qualified education expenses are not taxable income.
Other types of non-taxable student financial aid include:
- Tuition-assistance programs through your employer that go toward qualified education expenses.
- Federal and private student loans.
In fact, if you took out student loans, you may qualify for tax credits or deductions that can lower your or your family’s tax burden.
To report scholarship money that is taxable income, you will fill out a Form 1040 on line 7, with the total taxable amount listed under “wages, salaries, tips.” You may receive a W-2 with the listed scholarship amount, or your school will send you a tax form with the amounts indicated.