Tax - Educational Scholarships and Grants

One of the vexing questions that come up for a student is whether the scholarship he or she received is taxable or not. To be totally tax-free, there some requirements for the courses taken as well as the scholarships given.

Coverage should be related to tuition

The most important test is the purpose of the scholarship,in other words, what all expenses of the course it meets.

Scholarships, fellowships and grants become totally tax-free only if they cover tuition and some directly-related expenses.

Such expenses should be required for the courses e.g.,

books,

supplies,

and

equipment.

Coverage of living expenses is taxable

To be totally tax-free, the scholarship should not cover accommodation, food, travel, research and other incidental living expenses. So, if your scholarship covers such indirect living expenses also, only the portion that covers tuition and related expenses are tax-free. You will be paying taxes for the other part.

Scholarship should be for taking a "degree"

The student should be studying for a degree. If you are not a candidate for a degree your entire scholarship, fellowship or grant is taxable.

That brings us to the question: What is a degree?

While the term "degree" in common parlance is limited to post-secondary education, for tax purposes, it has a wider meaning. It can be education at a any of the following authorized institutions:

- primary school
- secondary school
- college
- university,

The following educational programs also qualify, provided such institutions are authorized under federal or state laws to provide such courses and are accredited by a nationally recognized accreditation agency:

(1) an educational program needed for full -time credit towards a higher degree
(2) a training program to prepare students for gainful employment in a recognized occupation.

Some conditional scholarships, grants, fellowships, and reimbursements may be taxable

When scholarships, tuition reimbursements or grants are paid in return for rendering teaching or other services, such educational assistance is taxable.

That is the case even if such services are a requirement for the award of the degree.

Graduate students who receive stipends for teaching have to pay taxes. Such remuneration is usually subject to tax withholding and details have to be included on a W-2 Form as for employed persons.

Conditional scholarships for Federal Employees

Interestingly, even federal government employees are not excluded from tax if they receive federal grants that require future work for the federal government.

The only exception allowed are for personnel who receive grants or tuition reduction for teaching, research, or other services as beneficiaries of the following federal programs,
- the National Health Services Corps Scholarship Program
- the Armed Forces Health Professions Scholarship and Financial Assistance Program.

Employer-provided scholarships

Employer provided tuition-related scholarships are tax-free IF,

1. The course enhances the skills required in your current position
2. The new degree acquired is NOT a minimum job requirement
3. The new degree DOES NOT qualify you for a new profession or business.

Usually such a tax-free scholarship goes straight to the educational institution at the beginning of a course or semester and not to nor through the employee and covers only the tuition.

But, it can be a different matter if the employer is actually reimbursing your educational expenses after you incur them. Most employers' partial educational assistance are of this type.

Any TAXABLE educational contributions provided by your employer should be stated on Form W-2. But, failure of the employer to do so doesn't absolve you from your tax liability.

PLEASE NOTE: This is only an introductory article on the subject. Please refer to resources provided by the Internal Revenue Service (IRS) for the latest and definitive information.