The Big Questions About Scholarship Taxability
By Matt Konrad
As the 2020-21 school year gets started, thousands of students and families are facing new circumstances and changed plans. Virtual campuses, sudden closures, transferring or taking a gap year can all have an effect on student financial situations—and, in some cases, may contribute to an unexpected tax bill for certain scholarship funds. Here are the four most pressing questions we’ve heard regarding scholarships and taxation right now.
Is my private scholarship taxable?
In general, scholarship funds cannot be treated as taxable income as long as you’re (a) pursuing a degree and (b) using the funds for tuition, fees or anything else that the IRS considers a “qualified education expense.” Those include books and supplies that are required for your program of study.
However, if you’re using all or part of your scholarship funds to cover room and board, travel, tutoring services or optional supplies, that money will be treated as taxable income. Since private scholarships are often more lenient about how funds can be used, it’s important to know in advance that you might face tax penalties—and if COVID-19 is affecting your living situation or adding extra technology or travel costs, make sure you plan accordingly so you don’t have any unpleasant surprises when tax season rolls around.
Here’s more on taxability, including a guide to the necessary IRS forms and worksheets. Keep reading for our tips on reducing your potential tax burden.
Are postgrad scholarships or teaching stipends subject to income tax?
Regardless of the campus situation, graduate student funding tends to be more of a gray area in terms of taxation. The same basic rule applies—scholarship funds used for tuition or required supplies are not taxable—but teaching stipends and fellowships can come with their own tax burdens.
Intuit, makers of TurboTax, offer a useful example:
In some cases, a scholarship is really more of a stipend, providing compensation for services while you’re in school or for services you’ll provide in the future. If, for example:
You receive a $5,000 scholarship with $1,500 of it designated to pay for your teaching services.
The $1,500 counts toward your taxable income for the year.
If you receive a scholarship with the condition that you provide services in the future, you’ll need to count the scholarship as income in the year you receive it. Payment for services at a military academy also count toward your taxable income.
This is obviously contingent on how your funding is structured, so it’s important to talk with your financial aid office before committing to an offer. (The same is true for any work-study funds, but teaching stipends are most likely to be bundled together with nontaxable scholarship funding.)
Postgraduate fellowships fall into a similar category, as you can hear in this episode of the Personal Finance for PhDs podcast. Since these funds are often used for living or traveling expenses, they’re among the most likely type of financial aid to be taxed—especially if you’re receiving them for a discrete research project rather than part of a degree program.
I received emergency aid for COVID-19 expenses. Do I have to pay taxes on it?
So far, all the news about COVID-19 emergency aid has been good. The IRS has confirmed that:
“Emergency financial aid grants under the CARES Act for unexpected expenses, unmet financial need, or expenses related to the disruption of campus operations on account of the COVID-19 pandemic, such as unexpected expenses for food, housing, course materials, technology, health care, or childcare, are qualified disaster relief payments under section 139 of the Internal Revenue Code. This grant is not includible in your gross income.”
One of the key phrases there is “qualified disaster relief payment”—this is a broad category of federal assistance that helps people recover in the face of natural disasters, and part of its legal definition is that it is not considered taxable income.
That said, if you or your college plans have been impacted by COVID-19, we encourage you to (a) follow the news and (b) know where your funds originated.
As negotiations for further relief measures continue in Washington, it is possible that future funding may not fall into the same tax-free category. And if you receive emergency aid funds in the form of a grant or scholarship from your state, school or a private provider, the tax rules outlined above may apply. As always: be aware of tax implications when you receive your funds, and avoid surprises later.
How can I reduce the chances that my scholarship is taxed?
In addition to staying aware, the best way to reduce your chances of scholarship taxation is to ensure that the money you earn from scholarships stays in the currently approved tax-free categories. When creating your budget, make sure you’re using the funds from scholarships toward tuition first, and then required fees and supplies.
If these costs end up being less than your total scholarship amount—or if COVID-19 circumstances are keeping you out of school or on a reduced schedule—talk with your scholarship provider and your financial aid office about a deferral. By keeping some of your scholarship award unused this year, you may be able to spread it out over multiple years’ worth of tuition.
You and your family may also want to explore putting funds into your state’s 529 college savings plan. Setting this up may require a professional financial adviser, but 529 funds also avoid some of the tax penalties that can affect scholarships.
Finally, if you receive private scholarships that can be used for living expenses, let your college’s financial aid office know. Your adviser may be able to help restructure your aid package from the school so you’re taxed on as little of your private funds as possible.