Are Scholarships Taxable?

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The information in this article is up to date for tax year 2024 (returns filed in 2025).

Scholarships are often seen as a saving grace for students who need help covering tuition and other college expenses.  Scoring a scholarship can reduce the amount you need to borrow, or help you avoid student loans altogether.  However, many students are unsure about whether the funds are considered taxable income by the IRS. Here’s what you need to know to avoid any tax pitfalls.

What are scholarships and how do they work?

A scholarship is a financial award given to students by a school, university or other organization.  They are meant to be used to cover the costs of tuition, fees, and other educational expenses. Unlike student loans, scholarships do not have to be repaid.  Most scholarships can be divided into two categories: merit-based and need-based.  What is the difference?

• Merit-based scholarships are awarded based on a student’s academic, athletic, or artistic achievements.  Typically, you are required to maintain a certain GPA to keep your scholarship.
• Need-based scholarships are given based on a student’s financial situation.  Usually, you are required to disclose your family’s household income to determine eligibility.

The difference between scholarships and grants

Scholarships and grants are both types of financial aid that you don’t have to pay back.  The main difference is that grants are given based on financial need and usually come from the federal or state government.  Scholarships are usually awarded based on your accomplishments.

Taxability of scholarships

Your scholarship or grant may be tax-free if you are pursuing a degree at an eligible educational institution.  It also depends on how the funds are used. If the scholarship is used for qualified education expenses and meets IRS requirements, it is generally not considered taxable income.  On the other hand, if you are a non-degree student or the scholarship is used for non-educational expenses, it may be subject to taxation. 

What are qualified education expenses?

To avoid paying taxes on your scholarship, you need to spend on the funds on qualified education expenses.  These are:

• Tuition
  • Fees required by a qualified educational institution for:
  • Enrollment
  • Attendance
• Course-related expenses, such as:
  • Fees
  • Books
  • Supplies
  • Equipment

When are scholarships taxable?

Your scholarship may be subject to taxation if you spend it on the following:

• Room and board
• Travel
• Research
• Clerical help
• Other school supplies not required as part of your enrolled program

Are scholarships on 1098-T taxable?

Scholarships reported on the 1098-T form are generally not taxable, if they are used for qualified education expenses. The 1098-T form is issued by your college or university to report the tuition and related expenses you paid during the year.  It is used to help you claim education tax credits such as the American Opportunity Tax Credit or Lifetime Learning Credit. 

• Box 1 shows how much you paid your school for qualified tuition and expenses during the year.
• Box 5 shows the amount of scholarships and grants that were paid to the school for your expenses.

You can only receive a tax credit for the portion of expenses you paid out of pocket.  If your scholarships were more than what you paid, you cannot use your expenses to claim an education credit.  You must also report the excess as taxable income on your tax return.  On the other hand, if the amount you paid was more than the scholarship you received, then you can use the expense to claim a tax break.

What happens if your scholarship is more than tuition?

If your scholarship funds are more than your total cost of attendance, your school may send you a refund of the leftover scholarship money.  You can do whatever you want with the funds, but you will have to pay taxes on it. 

Reporting scholarships on your tax return

If your scholarship funds are used for non-qualified expenses, you may need to report the amount as taxable income on your tax return. Even if you don’t receive a W-2 for the taxable portion, the IRS still expects you to report the information anyway.  So, it is important to keep detailed records of how your scholarship funds are used to ensure compliance with tax rules.  Here’s how to report your scholarship as taxable income on your tax return:

• Report the taxable amount listed in box 1 of your W-2 on Form 1040, line 1a.
• Any taxable amount not reported on your W-2 needs to be reported on Schedule 1, line 8r.

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Impact on financial aid

Getting an outside scholarship can impact the amount of financial aid you receive from your college. When combined, it cannot be more than your cost of attendance.  If your total aid package including outside scholarships and need-based aid ends up being more than $300 above your calculated need, your college is required to reduce your need-based aid.  This may mean cutting back your grant or reducing the amount of your loan.  If you don’t tell your college about your outside scholarship, you may have to pay back the “overaward”.

Tips for managing scholarship income

Scholarships can be helpful when it comes to paying for college, but there are some rules.  Most require you to maintain a minimum GPA, take a certain number of credits or play a specific sport throughout your college career.  If you don’t meet the requirements, you could lose your scholarship.  Here are some tips for managing your scholarship income effectively:

1. Read the fine print to understand what you need to do to maintain your eligibility.
2. Keep detailed records of how your scholarship funds are used.  Store all the paperwork in one place.
3. Know the GPA you need to maintain and stay on top of your schoolwork.
4. If your school has deadlines for renewal or reporting your GPA, make sure you know when they are, so you don’t miss out.

In conclusion, scholarships are typically not considered taxable income if they are used for qualified educational expenses. By following the tips outlined in this article, students can effectively manage their scholarship income and avoid any tax-related issues.

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The articles and content published on this blog are provided for informational purposes only. The information presented is not intended to be, and should not be taken as, legal, financial, or professional advice. Readers are advised to seek appropriate professional guidance and conduct their own due diligence before making any decisions based on the information provided.