Are Scholarships Taxable?

With college tuition rates on the rise, it’s no surprise that high schoolers are doing everything in their power to secure scholarships. Of course, reducing the cost of your education is generally regarded as a positive thing. However, students need to be conscious of the fact that some of the money they think of as free might actually come with a hefty tax bill down the line. So, are scholarships taxable? Keep reading for details on which scholarships come with tax exempt status and which will leave you footing the bill.

When Are Scholarships Tax-Exempt?

In most cases, the government refrains from taxing scholarship money that’s used to pay for tuition and other educational costs, such books and supplies. However, some scholarship money is considered taxable. In general, students have to meet the following criteria to enjoy tax-free scholarship funding:

• Be enrolled at an eligible educational institution
• Use the funds they receive for qualified academic expenses
• Refrain from using scholarship funds for room and board
• Refrain from accepting more scholarship money than they need to fund their education
• Not accept scholarship money as payment for teaching, research, or other educational services

Staying abreast of the above factors can help you avoid a costly tax bill down the line.

When Are Scholarships Taxable Income?

Not all scholarships are considered free money. The following situations may result in students paying taxes on their scholarship funding:

You’re Attending an Ineligible School: The IRS taxes scholarship money when students fail to attend an eligible educational institution. While the accepted list of schools includes most accredited public and private institutions, students should do their homework to find out whether their target colleges meet the criteria. 

You’re Not Pursuing a Degree: It’s not enough to be attending a qualified institution. To avoid taxes on scholarships, you also have to be on the path to earning a degree.

You’re Receiving Money for Nonqualified Expenses: To be considered tax exempt, scholarship money has to go toward qualified educational expenses. For example, a school may offer student athletes scholarships that apply to both tuition and room and board. While the part of the scholarship that goes toward tuition is tax exempt, recipients should expect to pay taxes on the part they use for room and board.

You’re Receiving the Money in Payment: Some college students receive scholarship money as payment for teaching classes or providing other services at the institution. This portion of their scholarship funding is considered taxable, as this is basically income from a job.

What Happens If Scholarships Exceed Your Cost of Attendance?

Sometimes students receive more scholarship money than they need to attend school. If your scholarship funding is greater than the total cost of your qualified educational expenses, you should expect to pay taxes on the amount that remains.

Depending on the terms of your scholarship, you may be able to use your scholarship to pay for the following expenses, if your scholarships exceed your educational expenses. Just be aware that you will be required to pay taxes on this funding.

The following items are not considered to be qualified educational expenses in the eyes of the U.S. government:

• Rent or mortgage payments
• Groceries or restaurant visits
• Insurance and medical costs
• Transportation 

How Outside Scholarships Impact Your Financial Aid Award

While some students receive scholarships directly from their college, others secure outside scholarships, which are funded by companies and organizations. While there’s nothing wrong with using outside scholarships to fund your degree, students should note that these financial awards come with certain requirements. 

When you secure an outside scholarship, you have to report the money to your college’s financial aid office. Most schools have limited financial resources, and if a student experiences a change in assets because of a new award, the institution may adjust your financial aid package and reduce the amount of grants they give you by the same amount. That way, available funding can go to those with greater need. Fortunately, schools generally remove less-desirable forms of aid, such as loans and work-study funding, before taking away scholarship money. They also may allow you to use funds for educational expenses like a laptop or books. So, winning an outside scholarship can only work in your favor (up to a certain point, as too much excess scholarship money could result in a reduction of your college’s financial aid award).

If you fail to report an outside scholarship, you may wind up receiving an “overaward.” In other words, the college disburses more money than you need to attend school. In some cases, students are required to pay back this money because they didn’t truly need it for educational expenses. Check out CollegeVine’s article on outside scholarships to learn more about how they can impact your financial aid.

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