Applying for a Scholarship? First Find Out If It’s Tax-Free

Getting a scholarship is a tremendous help to reduce the amount you may have to borrow to be able to go to college or completely avoid making a student loan. It’s more than being able to save money as well, it can also boost your self-esteem. You’d be proud to show off all of the academic or athletic accomplishments that made you qualify for the scholarship.

However, you could end up stuck with a large tax bill to pay off if the scholarship money is taxable. If you’re wondering whether or not scholarships are taxable income, read on.

When does scholarship money become tax-free?

The amount of money you receive from the scholarship is generally tax-free for as long as it meets the following requirements:

• You go to an eligible education institution to pursue a degree
• Your qualified education expenses are paid through the scholarship or fellowship
• The scholarship funds aren’t more than you’ll need for qualified education expenses.
• It’s not meant to or earmarked for other purposes — for example, room and board — and doesn’t demand that you use it exclusively for non-qualified education expenses only.
• It’s not treated as payment for teaching, research or other services.

If you’re attending school overseas, you can take advantage of the tax-free status. It also doesn’t matter who gave you the scholarship.

When does a scholarship become taxable?

Did you read the above requirements carefully? If you happen to not meet one or more of those requirements, you will be subject to pay taxes on some or all the money you received.

A scholarship is considered taxable income if they fall within these four specific situations:

1. You’re not pursuing a degree or your school isn’t eligible

If you’re not pursuing a degree or your school isn’t eligible, then you will be required to pay taxes. In order to find out whether the educational institution you go is eligible, the following requirements must be met:

• The institution offers higher education other than high school.
• It’s eligible to participate in a student aid program through the U.S. Department of Education.
• Most eligible education institutions are accredited public, nonprofit and private for-profit universities. To find out if yours is on the list, take a look at the Federal Student Aid code list. There are instances where the school is eligible but students cannot find it on the list, so it may be best to check with your school directly.

In addition to this, the IRS requires that the student is a candidate for a degree. This means those who take classes for fun or aren’t eligible for a degree for any other reason, you will have to pay taxes on any scholarship money you receive.

2. Your total qualified education expenses are higher than the funds

The IRS considers tuition fees, and other expenses required to enroll or attend school count as qualified education expenses.

Here is the list of expenses that aren’t counted as qualified expenses for the purpose of tax-free scholarships:

• Rent
• Groceries
• Insurance
• Medical expenses
• Transportation
• Other similar living expenses

You only need to remember that if some part of your scholarship funds is higher than your qualified education expenses, only a portion of is taxable.

3. When funds are earmarked for non-qualified expenses

The amount earmarked for the scholarship meant for non-qualified expenses is considered taxable. 

A student-athlete for example, don’t have a lot of extra time to get a part-time job. This will lead the college to offer an athletic scholarship that includes funds earmarked for both tuition and room and board. As you can see, if the scholarship requires you to use the money for the purpose of room and board, they are considered taxable income.

4. The funds are treated as payment for services

You will need to pay taxes if the money you receive from the scholarship is given under a condition that you offer some kind of service. The same rule applies if you can only get a scholarship after performing future services. To find out if there are any written stipulations or caveats, make sure you double-check in advance.

Exceptions

The following programs that give you part of any scholarship or fellowship is considered an exception to this rule:

• National Health Service Corps Scholarship Program
• The Armed Forces Health Professions Scholarship and Financial Assistance Program
• A comprehensive student work-learning-service program (as defined in section 448(e) of the Higher Education Act of 1965) operated by a work college (as defined in that section).