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Are Scholarships and Fellowships Taxable?

Updated on May 5, 2014
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Keith Schroeder writes The Wealthy Accountant blog with 30 years experience in the tax field. He is the tax adviser of Mr. Money Mustache.

College planning becomes crisis planning once students hit their senior year in high school. Saving for college is always a great idea, but young parents struggle to pay for necessities. As the college years approach, other college funding is explored.

The best way to pay for college is with scholarships, fellowships, and grants. This is money that never has to be repaid. Ramit Sethi, author of I Will Teach You to be Rich, says in his book that he became serious about applying for scholarships for six months, applying to three scholarships a day. In six month he had $200,000 in scholarship money.

I agree with Sethi. You should also get serious about scholarships. Do not burden yourself with a massive load of student debt. You can go to college if you are willing to work for it.

Clients in my office love the scholarship idea. The next logical question then is: Are scholarships taxable? The answer is: Sometimes. I will outline below when scholarships are taxable, when they are tax-free, and when to elect to pay tax anyway to get a bigger tax credit.

College Grad

Scholarship and Fellowship Exclusion

Scholarship and fellowship monies received by a degree candidate and used for tuition and other required enrollment fees are excluded from income in most cases. Scholarships received by a non-degree student are usually taxable.

There are two general rules to exclude scholarship monies from income:

  1. Student must be full- or part-time at a primary or secondary school, pursue a degree at a college/university, or an accredited educational institution.
  2. And monies used for qualified education expenses,including: tuition, enrollment fees, other required fees, books, supplies, and required equipment.

Use the worksheet at the end of this article to compute taxable and nontaxable scholarship receipts.

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Exclude, or Not To Exclude

When you choose to exclude scholarships and fellowships received from income, it lowers the amount of qualified expenses available for use in other tax credits. Many scholarships offer no choice and are excluded from income. However, if the scholarship terms allow for other expenses, such as room and board, you may gain a larger tax benefit by doing so. This will make the scholarship taxable, but you can now use qualified expenses for other tax credits such as the American Opportunities Credit and the Lifetime Learning Credit.

The choice to include or exclude scholarship funds only applies to unrestricted scholarships. Restricted scholarships for payment of qualified tuition and fees only will reduce qualified education expenses, thereby reducing any other tax credits available.

Scholarships for Services are Usually Taxable

If a scholarship requires recipient to perform services in the present or future as a condition of the scholarship, the scholarship must be included in income, unless the scholarship is received from the National Health Services Corps Scholarship Program (NHSCSP), the Armed Forces Health Professions Scholarship Program (AFHPSP), or the Financial Assistance Program (FAP), providing the recipient is a degree candidate and the scholarship is used for qualified education expenses (tuition, fees, books, supplies, and required equipment).

Taxable Scholarship Income Worksheet

1) Enter scholarship/fellowship income for the year here.
1)
*If a degree candidate, go to line 2.
 
*If not a degree candidate, stop here, all is taxable.
 
2) Line 1 amounts for teaching or other services.
2)
*Do not include NHSCSP, AFHPSP, or FAP amounts.
 
3) Subtract line 2 from line 1.
3)
4) Enter amount from line 3 used for other than qualified education expenses.
4)
5) Subtract line 4 from line 3.
5)
6) Enter line 5 amount used for qualified education expenses at eligible education institution.
6)
*This is the tax-free scholarship amount.
 
7) Subtract line 6 from line5.
7)
8) Add lines 2, 4, and 7. Taxable scholarship amount.
8)
Enter line 8 on Form 1040, line 7. Write SCH on dotted line next to line 7.
 
Source: IRS Pub 970 with modifications by author for clarification.

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