All or part of your scholarship to college may be taxable. Shocking isn’t it?
Scholarships are the only form of generosity that can be taxable for the recipient. When a donor donates money to a homeless shelter or soup kitchen, the services are tax-free for the beneficiary.
However, if the donor is providing a scholarship that covers a student’s room and board costs, the scholarship is deemed to be taxable income for the recipient. This also applies if, according to a national survey in 2019, before the pandemic, more than half of college students suffer from food insecurity or housing insecurity.
The scholarship tax prevents students from being able to take full advantage of their scholarships. Find out the rules for tax-exempt and taxable grants.
Growth in Taxable Scholarships
The number and amount of taxable scholarships that are shown in federal income tax returns has increased significantly in recent years. This table is based on estimates given in the IRS income statistics.
Number of returns
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Which scholarships are tax-free?
The 1986 Internal Revenue Code, 26 USC 117, sets out several requirements for the tax treatment of grants. Below, these rules are broken down to show the differences between tax-exempt and taxable grants.
Tuition, Fees, Books and Supplies
In general, for a scholarship to be taxable it must be used to pay for tuition and required fees, books, supplies, or equipment. Only the portion of the scholarship that is used to pay those qualifying tuition fees and related costs is tax-free.
If an educational institution grants its faculty and its staff a tuition waiver or a tuition fee reduction, it is tax-exempt if that benefit is granted to all members of a group of staff on essentially the same basis. The group of workers must not discriminate in favor of executives, owners and highly paid workers.
The student must pursue a degree or certificate from an accredited educational institution. Otherwise, the entire amount of the scholarship is taxable.
The portion of a grant that is used to pay for room and board, transportation, disability expenses, care expenses, and other living expenses is taxable. This includes amounts earmarked for living expenses, e.g. B. a living grant, even if the recipient uses the grant to pay for qualifying tuition fees and related expenses.
Fee for services
If a grant is viewed as a fee for services such as employee benefits, the entire amount of the grant is taxable. A scholarship is considered a fee for services if the services are required as a prerequisite for receiving the scholarship. However, there are exceptions for graduate teaching and research assistants and certain federal health care professions.
The rules above apply to all types of scholarships and grants, including private scholarships, sports scholarships, Pell scholarships, and Fulbright scholarships. However, veteran training benefits are tax-free.
Emergency financial aid grants under the CARES Act in connection with the COVID-19 pandemic are tax-free, even if they are used to cover the cost of living. This provision is limited to qualified disaster relief payments for the duration of the pandemic (26 USC 139). It does not apply to other taxable scholarships.
How to Report a Taxable Scholarship
Recipients of taxable scholarships, grants, grants and tuition fee exemptions during the tax year must state the taxable part in their federal income tax return.
The taxable amount of the scholarship should be reported on line 1 of the IRS Form 1040. If the taxable amount of the scholarship was not provided on IRS Form W-2, write “SCH” and the taxable amount on the dotted line next to line 1.
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Workarounds for Scholarship Tax Treatment
Scholarship providers have started looking for ways to provide scholarships that reduce the tax impact. This includes awarding the scholarship as a contribution to the student’s savings plan or by granting the student loan.
An added benefit is that these alternatives can eliminate or reduce scholarship relocation. A scholarship deferral occurs when a college reduces the amount of its own scholarships after the student receives an on-demand scholarship. If a scholarship is used in the calculation of the expected family contribution (EFC), the scholarship cannot be postponed.
Typically, the taxable portion of a scholarship is deducted from the total income of the Free State Student Aid Application (FAFSA). Receiving a scholarship has no impact on the EFC. However, if a scholarship is awarded as a contribution to the student’s 529 college savings plan, which is accounted for as an asset in the FAFSA, it will have little impact on the EFC (up to a 5.64% increase in the scholarship amount).
If a scholarship is awarded through the granting of student loans after graduation, this also has no influence on the eligibility of the student for need-based financial support.