Winning a scholarship can help make covering the cost of college much more manageable. And unlike student loans, which you have to pay back, scholarships are money that is gifted to you free and clear — well, almost.
In some cases, you may have to pay taxes on that scholarship money. So, what are those cases? The problem with that question is “answering it often seems to require a Ph.D.,” with confusion abounding among both parents and students, said The Wall Street Journal. Figuring it out in advance, however, is key to minimizing tax impacts or at the very least being aware of them.
When do taxes not apply to scholarships?
Perhaps it is first easier to understand when you do not owe taxes on scholarship funds. “A general rule is that your college scholarship is tax-free when it is used to pay for ‘qualified education expenses,’” said Kiplinger. These are the costs that are “typically limited to items required for all students to attend a particular institution” — think “tuition, fees, books and supplies.”
The student, as well as the school, must also meet certain requirements for the scholarship money to be tax-free. Specifically, the student must be a “candidate for a degree at an educational institution that has regular faculty, regular curriculum and a regularly enrolled population of students in attendance,” said H&R Block.
When do you owe taxes on scholarships?
If you use your scholarship funds for costs beyond what is absolutely required for all students in attendance at the program, then income taxes will generally apply. So, for instance, “if a student uses scholarship dollars to buy a computer that’s not required, those funds are likely taxable,” said the Journal. The same goes for “funds used to pay for room, board, most travel and optional expenses,” as well as any “money the student receives for other services, such as office work,” alongside “stipends for living expenses.”
Additionally, for your scholarship to be tax-free, the amount cannot exceed your qualified education expenses. “If your scholarship exceeds the amount of your qualified education expenses, you may need to report the excess amount on your tax return,” said Kiplinger.
How should you report a taxable scholarship?
If your scholarship is indeed taxable, you will need to report that to the federal government. The process for doing so is the same as it is for any other income.
You will report the taxable scholarship amount using either Form 1040, Form 1040A or Form 1040E Z on the line labeled “Wages, salaries, tips.” If “no W-2, Wage and Tax Statement was received, also enter ‘SCH’ by the taxable amount,” said H&R Block.