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Tax Implications of College Scholarships

Once school gets rolling for college and the tuition bill is paid, it’s easy to put away thoughts about scholarship funding. But with the end of the year fast approaching, it’s not too early to review the tax implications of college-related expenses. How you or your student spends scholarship money, and whether there is any work that coincides with the grant affects whether the scholarship is taxable or not.

Tax-free scholarships and fellowships

For scholarship or fellowship to be considered tax free by the IRS, the use of the money must meet the following criteria:

  • The educational institution must have a regular faculty, curriculum, and body of students.
  • The student must be a degree candidate.
  • Scholarship money must be used for qualified expenses: tuition and fees, books, and course- or degree-related costs, such as supplies for the course. Non-qualified expenses are costs such as travel or room and board.
  • No work must be required from the student, such as teaching.

If any portion of the scholarship money is used for non-qualified expenses, then that portion of the scholarship is considered taxable income. Therefore, it is important to keep accurate records that match money received with money spent. (If student loans are involved, they are not taxable because the amount will be repaid.)

Other tax-free options
Certain government programs are not taxable:

  • The National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship and Financial Assistance Program
  • GI Bill payments (not a scholarship, but paid by the government)

Taxable scholarships
There are two ways that scholarships or fellowships become taxable to the recipient:

  • If receipt of the money is connected to working for the educational institution, such as being a teaching assistant, then the money is considered compensation, even if it is used for qualified expenses.
  • If the student fails to remain in a degree program (is not actively enrolled), then the scholarship money is considered regular income.

How to reduce taxes on educational expenses
Based on your income, you may qualify for a tax credit or deduction:

  • Those with modified adjusted gross income (MAGI) of $80,000 or less (or $160,000 for married filing jointly) qualify for the American Opportunity Tax Credit (AOTC) of a maximum $2,500 per student for four years (through 2017).
  • MAGI of less than $65,000 (or $130,000 for married filing jointly) qualifies the taxpayer for up to $2,500 in student loan interest deduction.
  • MAGI of $55,000 or less ($110,000 for married filing jointly) qualifies for a tax credit maximum of $2,000 per year (no limit to number of years) for the Lifetime Learning Credit (LLC). The amount is per tax return for undergraduate, graduate, or other professional degree courses.
  • Alternately, you may deduct $4,000 for yourself, spouse, or dependent for qualified tuition and expenses. You may not claim both a credit and a deduction in the same tax year.

Note: When claiming a tax credit, if you qualify for both, you may only take one of the credits. If you have questions about taxes related to scholarships or tax credit income levels, please talk with your Salmon Sims Thomas tax advisor.