If your child is fortunate enough to be awarded a scholarship, you may wonder about the tax implications. Fortunately, scholarships (and fellowships) are generally tax free for students at elementary, middle, and high schools, as well as those attending college, graduate school, or accredited vocational schools. It does not matter if the scholarship makes a direct payment to the individual or reduces tuition.
Requirements for Tax-Free Treatment
However, scholarships are not always tax free. Certain conditions must be satisfied. A scholarship is tax free only to the extent it is used to pay for the following:
- Tuition and fees required to attend the school
- Fees, books, supplies, and equipment required of all students in a particular course
For example, expenses that do not qualify include the cost of room and board, travel, research, and clerical help.
To the extent a scholarship award is not used for qualifying items, it is taxable. The recipient is responsible for establishing how much of an award is used to pay for tuition and eligible expenses. Maintain records (such as copies of bills, receipts, and cancelled checks) that reflect the use of the scholarship money.
Payment for Services Does Not Qualify
Subject to limited exceptions, a scholarship is not tax free if the payments are linked to services that your child performs as a condition for receiving the award, even if the services are required of all degree candidates. Therefore, a stipend your child receives for required teaching, research, or other services is taxable, even if the child uses the money for tuition or related expenses.
What if you, or a family member, are an employee of an education institution that provides reduced or free tuition? A reduction in tuition provided to you, your spouse, or your dependents by the school at which you work is not included in your income and is not subject to tax.
What is Reported on a Tax Return?
If a scholarship is tax free and your child has no other income, the award does not have to be reported on a tax return. However, any portion of an award that is taxable as payment for services is treated as wages. Estimated tax payments may have to be made if the payor does not withhold enough tax. Your child should receive a Form W-2 showing the amount of these ‘wages’ and the amount of tax withheld, and any portion of the award that is taxable must be reported, even if no Form W-2 is received.
These are just the basic rules. Other rules and limitations may apply. For example, if your child’s scholarship is taxable, it may limit other higher education tax benefits to which you or your child are entitled. Contact us if you would like to discuss these or other tax matters further.