What to understand about Scholarships and Fellowship Grants to determine if they are taxable or non-taxable to your Student

Soon many students will be heading back to college and many parents will be paying for their education costs. Hopefully, your student qualified for a scholarship to help offset these higher education costs. But, do you know the tax implications of your student’s scholarship or fellowship grant? This article will briefly explain the differences between taxable and non-taxable scholarships and grants.

Under Code Section 117, many scholarships and fellowship grants are not included in gross income and thus are not taxable to the student. Many scholarships that cover qualified tuition and related expenses and are used by the student who is a candidate for a degree will not be taxable. Qualified tuition and related expenses include ‘required’ tuition, fees, books, supplies and equipment.

So, when is a scholarship or fellowship grant considered taxable? A scholarship or grant that is earmarked to cover non-qualified tuition and related expenses are taxable to the student. As an example, a scholarship earmarked for room and board would be considered taxable. Also, payments for services are included in income and would be taxable. If services are deemed to have been performed, the college or university will issue the student a Form W-2. There are a few exceptions to this rule, such as, graduate students who receive tuition reductions in exchange for teaching or research activities for the educational institution. There are other examples, but they are beyond the scope of this article.

Note, the IRS has not chosen to press the issue for students that are required to perform a service in exchange for their scholarship (i.e., athletes/athletic scholarships). Currently, these scholarships are not includible in income and are not taxable to the student.

Furthermore, we raise caution to parents and students that receive full-ride scholarships or grants. Tax implications will result when the scholarship or grant not only covers tuition but also covers room and board. As mentioned previously, room and board is not a qualifying education expense under Code Section 117. So, the portion of the scholarship or grant that is earmarked for room and board will be includible in the student’s gross income.

Understanding what higher education costs the scholarship or grant covers will help parents and students understand the potential tax implications they could face. Proactive tax planning should be performed to minimize the tax implications. Please consult with your tax advisor at Greenwalt CPAs before year end.