Do I Have a Tax Free Scholarship?
Do I have to Pay Taxes on My Scholarship or Fellowship? Maybe.
Have you ever heard the expression “There is no such a thing as a free lunch?” When it comes to fellowships, grants and other free money from a college, you may not have a tax free scholarship.
Financial aid that you receive for higher education expenses, even when the college says its free, doesn’t mean that it is. Depending upon how the money is used, you could end up owing the IRS big bucks.
Various types of financial assistance, such as fellowship grants, scholarships, and teaching assistantships, are very important to families. Often times, it may determine if your child will be able to attend the college of his/her choice.
College tuition and other associated expenses have been rising for years. Currently, the average fees and tuition for a full-time student attending a public college in state is 25,290.00. The average for a private college is 50,900.00.
This is why its very important to find out if your free money is really free, and not subject to income tax. In general, a tax free scholarship is one that covers tuition and fees. Any money that you receive for room and board (housing) is not. Unfortunately, the difference isn’t always made clear by the college.
Sometimes, the college itself creates a problem for you. They’ll say, we’re going to give you 10,000.00 and will call it a scholarship. It may or may not be tax-free, depending on how its spent and reported.
IRS conditions to consider one as a tax free scholarship
According to the IRS, students need to satisfy two conditions that will classify their fellowship or scholarship as tax-free money. The first is the educational institution where you are a candidate, must have a curriculum and a regular faculty. It must also have a body of students regularly attending.
The second is any money you receive, covers the cost of books, enrollment fees, supplies and equipment, fees required for courses, and tuition.
Examples of taxable money are room, travel, board, any incidental expenses. In addition, any money that you receive for research, teaching, and any other services conditioned of receiving money is taxable.
You should also be aware that any amount of a tax free scholarship received in excess of your actual cost of tuition, fees, books, equipment, and supplies is taxable.
There are a couple of exceptions for students in the Armed Forces Health Professions and the National Health Service Corps. Their money is tax-free.
The research assistantships and fellowships programs usually combine a tax-free waiver of tuition and a living stipend that is taxable income. How you use those monies and the stated purpose are very important. Keep all receipts and what money was used for them.
A college must issue a W-2 for services paid
If a college pays a student money, say for a part of a teaching assistant-ship, they are required to issue a W-2 to the student and report all taxes withheld.
The school will also send the student a Form 1098-T detailing qualified tuition paid plus the amount of any grants, fellowships, or scholarships received.
Keep all of your receipts so that you can match them with the Form 1098-T.
If the fellowship or scholarship is taxable, its considered unearned income. That means if the student is under age 19 or a full-time student under the age of 24, the income is subject to the kiddie tax.
Prior to 2018, the old tax code would have taxed the unearned income in excess of 2,100.00, as subject to the parent’s tax rate by filing Form 8615.
The new tax rates that kicked in for 2018 are not as kind. This unearned income will now be taxed at Trust tax rates. What that means is that income in excess of 12,500.00 is taxed at the rate of 37 percent. If this situation exists for you in 2018, we strongly suggest you contact a qualified tax preparer. The new law is a bit tricky and if you are unsure, you could get burned.
Waivers of tuition can be very high, especially if they are for a full school year, and graduate students need to be aware that Congress considered taxing that last fall. Until government spending is curtailed, especially the pork projects, Congress is looking for new avenues to tax.
Factor in the taxation of free money when considering a school
Taxation of free money should be added to the list of factors that need to be considered when a college is selected.
When talking with your financial aid officer, there are a number of questions that should be asked.
- Does the fellowship or scholarship include a payment for a service? As an example, if the college gives you 15,000.00 for conducting research at the school, request a breakdown of the money. What portion is the scholarship? (This amount may be tax-free) What portion is for payment for doing research? ( That amount is probably taxable income).
- Are there any tax documents that will be sent to me? If any part of the money is considered wages, you should be getting a W-2).
- You need to calculate the actual cost after taxes and financial aid. Once you have that number, it should be factored in to get the net cost, and you will be able to compare the offers you received from all of the schools.
Just make sure that you factor in the impact of taxes on any fellowship or a tax free scholarship that may be taxable.
An accountant and tax preparer by profession, Gust’s true passion lies in his company blog titled “HBS Financial Group, Ltd.”. Through this venue, he not only tries to teach individuals about budgeting, money management, and taxation but he writes the majority of the articles as well.