Scholarships are Usually Tax Free but May Result in Taxable Income
Geoffrey Kayton, CPA
08.23.21 | TAX Chat
If your child is fortunate enough to be awarded a scholarship, you may wonder about the tax implications. Fortunately, scholarships (and fellowships) are generally tax free for students at elementary, middle, and high schools, as well as those attending college, graduate school, or accredited vocational schools. It doesn’t matter if the scholarship makes a direct payment to the individual or reduces tuition.
Requirements for Tax Free Treatment
However, scholarships are not always tax free. Certain conditions must be satisfied. A scholarship is tax free only to the extent it’s used to pay for:
- Tuition and fees required to attend the school and
- Fees, books, supplies, and equipment required of all students in a particular course.
For example, expenses that don’t qualify include the cost of room and board, travel, research, and clerical help.
To the extent a scholarship award isn’t used for qualifying items, it’s taxable. The recipient is responsible for establishing how much of an award is used to pay for tuition and eligible expenses. Maintain records (such as copies of bills, receipts, and canceled checks) that reflect the use of the scholarship money.
Payment for Services Doesn’t Qualify
Subject to limited exceptions, a scholarship isn’t tax free if the payments are linked to services that your child performs as a condition for receiving the award, even if the services are required of all degree candidates. Therefore, a stipend your child receives for required teaching, research, or other services is taxable, even if the child uses the money for tuition or related expenses.
What if you, or a family member, are an employee of an education institution that provides reduced or free tuition? A reduction in tuition provided to you, your spouse, or your dependents by the school at which you work isn’t included in your income and isn’t subject to tax.
What is Reported on a Tax Return?
If a scholarship is tax free and your child has no other income, the award doesn’t have to be reported on a tax return. However, any portion of an award that’s taxable as payment for services is treated as wages. Estimated tax payments may have to be made if the payor doesn’t withhold enough tax. Your child should receive a Form W-2 showing the amount of these “wages” and the amount of tax withheld, and any portion of the award that’s taxable must be reported, even if no Form W-2 is received.
These are just the basic rules. Other rules and limitations may apply. For example, if your child’s scholarship is taxable, it may limit other higher education tax benefits to which you or your child are entitled. As we approach the new academic year, best wishes for your child’s success in school. Contact us if you’d like to discuss these or other tax matters further.
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Geoffrey Kayton is a Senior Tax Manager with more than 10 years of professional experience. He advises a diverse array of clients across the real estate sector on a variety of tax matters.