The news that you or your child has won a scholarship is a huge relief — that is, until you think about paying taxes on it. Although this is a common question, there isn’t a straightforward answer for whether college scholarships are taxable. This is because what determines a taxable scholarship is based on a variety of factors, including how you’ll use the money and what school you’re attending.
We’ll cover everything you need to know in order to decide if you need to set aside some of your scholarship money for taxes.
When college scholarships are not taxable.
Most scholarships are tax free, but certain conditions must be met first. As a student, you must be a degree candidate at an eligible institution. In other words, you must attend a college that has regular faculty and other enrolled students. It is unlikely that anyone who has applied for a scholarship would not meet this particular criterion.
The scholarship money must be used for degree-related costs, not college-related costs. Many scholarships that are given directly by the school are automatically applied to your tuition, and you never have to worry about how to spend them. Scholarships from third parties, however, are different.
Many scholarships are offered by organizations outside the school. These scholarships can be deposited into your bank account, and you are free to spend them as you see fit. If you spend the money on tuition, fees, books or supplies for a class or lab, then it is still considered tax free.
If you spend the money on room and board or on a meal plan at the cafeteria, then it becomes taxable. For scholarship money to be tax free, it must be spent on things which are directly related to earning your degree, not on living expenses associated with attending college.
The scholarship money also cannot represent wages. In other words, if you receive a scholarship in payment for taking on a teaching assistant job, it won’t matter how the money is spent, it’s all taxable.
Any scholarship money spent on qualified expenses is tax free, while any money spent on non-qualified expenses is taxable. So, if the scholarship is for $10,000, and $2,000 is used to pay for the dorm room, while the remaining $8,000 pays for tuition and books, only the $2,000 is taxable.
When college scholarships are taxable.
We’ve already established that any scholarship money is taxable when it is used to pay for expenses that aren’t directly related to earning a degree. For most undergraduate students, there are very few scenarios in which a scholarship becomes taxable.
Graduate students are far more likely to receive scholarship money as compensation for work, which makes the scholarship taxable income. If this is the case, it doesn’t matter what the money is spent on. It’s taxable simply because it is considered income.
One crucial thing to remember is this. A college scholarship can only be tax free if the money is used for degree-related expenses. We’ve already mentioned this, but it’s worth saying again if only to point out that you can only have degree-related expenses if you are enrolled in a degree program.
If the student receiving the scholarship is not enrolled in a degree program, then the scholarship is taxable, no matter how the money is spent. It’s worth enrolling in a degree program as soon as possible, even if you might change degree plans later. Switching degree plans won’t have any effect on the taxes you pay. That means it could end up being more expensive to enroll as an undecided student than to enroll in a specific degree plan.
Things to remember.
The most important thing for you to remember is the total amount of the scholarship and the total cost of tuition, fees and books. You may well find that the scholarship exceeds those costs. If that’s the case, you have a decision to make.
You can use the extra scholarship money to pay for other expenses — room and board, meal plans, etc. It will be taxable at that point, but it’s worth remembering that the taxes on the scholarship money will still be less than the cost of paying for those expenses out of pocket.
If you’d rather not use scholarship money to pay for those non-qualified expenses, the easiest thing to do is to only accept the amount of money you need for qualified expenses. People tend to forget that you don’t have accept the full value of a scholarship if you don’t need it.
In fact, that’s a good thing to remember even if you want to use to your scholarship money for non-qualified expenses. If the total amount that you need is less than the amount of money being offered in the scholarship, there’s no reason to accept the full amount. In fact, doing so would be a bad idea since you’d then end up paying taxes on a lot of money that wouldn’t be benefiting you much.
Some awardees like to use excess scholarship money to pay for other living expenses like gas, food, bills, etc. This isn’t a terrible idea, necessarily, but you may want to consider getting a part-time job to cover those expenses.
You’ll likely end up with more money in the bank, and if you can find a job related to your degree or career path, you’ll gain a lot of valuable experience and networking that will put you ahead of your classmates when you graduate. Plus, if you’re living on nothing but your scholarship money, you’re going to find it difficult to pay the taxes on it when they’re due.
Scholarships are arguably the best way to pay for college. You won’t rack up debt and you’ll at least save money on tuition, if not avoid paying it out of pocket entirely. And, for the most part, you don’t have to worry about paying taxes on scholarship money. Even if you choose to use scholarship money on non-qualified expenses, paying the taxes on that money could still be cheaper than paying for those expenses out of pocket.