College scholarships provide significant help to students. But, do scholarships count as taxable income? It depends on how they’re used.
- When are scholarships considered taxable income?
- Taxable scholarship funds
- Taxable stipend scholarships
- Scholarships vs. grants
- What tax credits are available to pay for higher education?
- American Opportunity Credit
- Lifetime Learning Credit
- How to maximize your scholarships and tax credits
- Tax deduction for student loan interest
- How can I avoid paying taxes on scholarships?
• Scholarships that pay for qualified educational expenses at qualified educational institutions generally don’t count as taxable income.
• Scholarship funds received in excess of your qualified educational expenses may be taxable and might need to be reported in your taxable income.
• The American Opportunity and Lifetime Learning tax credits can help lower the cost of attending post-secondary educational institutions.
Are scholarships taxable?
Typically, scholarships that pay for qualified educational costs at eligible educational institutions aren’t considered taxable income. The same applies to grants received to pay for specific schooling costs. In short, whether scholarships are taxable depends on how much you receive and how you spend the funds. In fact, some scholarships can be at least partially taxable.
When are scholarships not taxed?
The IRS has specific conditions for a scholarship not to be taxed. A scholarship is tax-free only if:
- You are a degree-seeking candidate
- Attend a qualified educational institution
- It doesn’t exceed your qualified education expenses
- It isn’t designated for other non-qualified purposes (such as room and board)
- It doesn’t represent payment for work or services you’ve performed
The IRS defines a candidate for a degree as someone who either attends primary or secondary school (K-12) or attends college to pursue a degree. Or you can attend an educational institution that:
- Provides a program which can be used as full and acceptable course credit toward a bachelor's or higher degree, or offers a training preparation program for students seeking gainful employment in a recognized occupation; and
- Has received a nationally recognized accreditation status and is authorized under federal or state law to provide a program of study.
What are qualified educational expenses?
To avoid a scholarship being subject to taxation, you’ll need to spend the funds on qualified educational expenses. Generally, this means tuition and fees required to enroll or attend the eligible educational institution. But it can also include costs such as course-related expenses like fees, books, supplies, and equipment required for courses at the institution.
The key requirement for having scholarships cover these course-related expenses tax-free, is that they must be required of all students in your course. They can’t be optional expenses you elect to pay that aren’t required to satisfy the requirements of the course or educational institution.
When are scholarships considered taxable income?
You might have some of your scholarship or grant count as taxable income under certain circumstances.
Taxable scholarship funds
Some scholarship funds are subject to taxation. If you have scholarship money left over after covering your qualified education expenses, you'll need to include that amount as part of your gross taxable income. That means scholarship money counts as income when calculating your tax liability when used to pay for:
- Room or board
- And other non-qualified expenses (including school supplies not listed as required in your program).
If you have money left over after covering your qualified education expenses and use it on other costs, these funds generally count as taxable income. For example, if you use your scholarship funds for optional reading assignments that don’t go toward satisfying course requirements and aren’t required of every student, they would be subject to taxation.
Taxable stipend scholarships
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 typically counts toward your taxable income for the year.
- The remaining $3,500 is usually not taxable, as long as you're a degree student at a qualifying institution and the money is used for qualified education expenses.
If you receive a scholarship with the condition that you provide services in the future, you’ll typically need to count the scholarship as income in the year you receive it. Payment for services at a military academy also counts toward your taxable income.
If you receive scholarship funds that exceed your qualifying educational expenses, the amount above these necessary costs is subject to taxation. Likewise, if you receive a scholarship that you use to pay for room and board, books or supplies that aren't required, these funds are generally subject to taxation. Commonly, schools offer scholarships to worthy students, essentially counting as a reduction in the cost of attendance rather than funds given from a third-party.
Scholarships vs. grants
Scholarships are financial awards often given to students who meet certain need-based criteria or merit-based achievements based on their academic, athletic or extracurricular performance, or on other areas of interest like field of study, hobbies and more. Scholarships aren't like student loans, meaning they don't need to be repaid.
Grants are a form of financial aid that don’t require repayment. Generally, grants are awarded based solely on financial need. One common example is the Pell Grant, which is awarded solely on the difference between the expected cost and family contribution amounts.
Depending on how the student uses scholarship funds, they are typically not considered taxable income. Grants are usually awarded by federal and state governments and are generally not taxable if used for paying qualified expenses to attend an eligible educational institution while pursuing a degree.
What tax credits are available to pay for higher education?
Scholarships and grants aren’t the only ways to get financial assistance to pay for higher education. The tax code also has two educational tax credits geared toward lowering the cost of pursuing post-secondary education.
American Opportunity Credit
The American Opportunity Credit allows students or their parents an opportunity to reduce the cost of attending college through claiming qualifying education expenses as a tax credit on their federal income taxes. The credit reduces the tax you owe on a dollar-for-dollar basis rather than just reducing the amount of income subject to tax as a deduction would.
To claim this education tax credit, the student must be at least a half-time student who hasn’t completed the first four years of college and is working toward a degree. In addition to required tuition and fees, the credit applies to other expenses like books, supplies and equipment, but not room, board, transportation expenses or medical insurance. The credit is equal to 100% of the first $2,000 of qualifying expenses plus 25% of the expenses in excess of $2,000. The maximum credit per student per year is $2,500.
Lifetime Learning Credit
Whether you’re pursuing a college degree, higher education coursework independent of a degree or other educational activities to develop your career, another tax credit to consider is the Lifetime Learning Credit. Like the American Opportunity Credit, this credit also reduces your tax bill on a dollar-for-dollar basis for a portion of the tuition, fees and other qualifying expenses you pay for yourself, your spouse or a dependent to enroll in qualifying coursework. However, this credit doesn’t require you or your dependent to be taking this coursework to satisfy the requirements of a degree.
The Lifetime Learning Credit is equal to 20% of the first $10,000 of spending for a maximum of $2,000.
Another distinction is that you can’t double dip with these two educational credits. That means you can’t claim both the Lifetime Learning Credit and the American Opportunity Credit in the same year for the same student. You need to choose between them.
The American Opportunity Credit is available for each qualifying person on a tax return, while only one Lifetime Learning Credit can be claimed on each tax return.
How to maximize your scholarships and tax credits
The IRS has provided some helpful guidance on how to maximize your scholarships and tax credits, delivering you the most savings possible for your situation. One tax optimization strategy works by considering some of your scholarship money as taxable income by using it for living expenses rather than applying it toward your tuition expenses. This can allow for some of your tuition expenses to be eligible for an education credit that otherwise would have been paid by the tax-free scholarship money. In some cases, you might be better off excluding all of the scholarship from your taxable income by applying it only toward tuition expenses. In others, it might make sense to claim some as taxable income and use the tax credits to lower your tax bill.
For example, if you have a grant or scholarship that fully covers all of your tuition, fees, and books, then you can't claim the American Opportunity Credit because you didn't actually pay for qualifying expenses. If, instead, you claim some of the grant or scholarship as income and don’t use it for your eligible expenses, this then leaves you with some qualified expenses to pay and gives you the ability to claim the tax credit. Since up to $1,000 of the American Opportunity Credit is refundable, you can take part of a scholarship and choose to make it taxable income. Then, you can have part of the American Opportunity Credit pay the tax and receive up to $1,000 as a refund without ever having paid any taxes.
Tax deduction for student loan interest
Another useful tax deduction you may be able to claim comes from the student loan interest deduction. If you used student loans to finance all or part of your college education, the tax code provides the ability for many borrowers to deduct the interest paid on these student loans.
For 2023, you can deduct the student loan interest paid if your modified adjusted gross income (MAGI) is below $90,000 as a single filer or $185,000 if you file a joint return. The ability to claim the deduction begins to phase out at $75,000 for single filers and $155,000 for joint filers.
How can I avoid paying taxes on scholarships?
For scholarships to be completely tax-free, the money you receive has to go toward paying qualified educational expenses at qualified educational institutions. In some cases, scholarship funds can exceed this amount. Scholarship funds that go toward certain non-qualified expenses like room and board are typically taxable income.
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