The costs of education continue to rise year after year. Tuition, fees, books, school supplies are just a few of the yearly costs for students. No matter if you have younger children just starting their elementary education, are helping your kids with college applications, or fall somewhere in between scholarships can be a beneficial way to help reduce the costs of education.
If you are fortunate enough to receive a scholarship the first thing on your mind might not be the tax implications associated with the money you receive. While scholarships are usually tax free, it is not always the case. Here are some things to consider.
Requirements for Tax-Exempt Treatment
Income received from a scholarship is only considered tax free if certain criteria are met. The money must be used for the following to be tax free:
- Tuition and fees required to attend the school or
- Fees, books, required equipment need by all students in a particular class, and school supplies.
If the scholarship is not used for the above stated items, it is considered taxable income. That means scholarship funds used to pay for related educational expenditures including room and board, travel, research, or other personal expenses would make these funds subject to income tax.
This makes it essential to maintain proper documentation including all receipts and bills related to the spending of the scholarship funds. It is the scholarship recipient’s responsibility to provide proof of what the funds were spent on.
Payments for Services do NOT Qualify
Service based scholarships do not qualify for tax exempt treatment either. These types of scholarships usually require the recipients to complete certain obligations or services to receive the scholarship funds. For example, if a stipend is received for student teaching, various grad student research activities, or job focused activities performed by interns or apprentices this is to be treated as taxable income even if this money is used for tuition and other qualifying educational expenses.
However, if an educational institution provides reduced tuition or free tuition as an employee benefit to employees and members of the employee’s family this is a tax-exempt employee benefit and does not need to be included in taxable income.
How to Report on My Tax Return
As a basic rule, any amount received in return for services rendered, such as a stipend, needs to be treated as wages. A W-2 would be sent showing a portion of taxable income that would need to be reported on your individual tax return. In the case a W-2 is not sent, any taxable amount would still need to be reported as income. If the scholarship funds meet the requirements to be considered tax free income and your child has no other income, these amounts do not have to be included on your tax return.
As is usually the case in tax law, other rules and limitations may apply based on other income and deductions reported on your return.
Please contact your tax advisor at Wegner CPAs for any questions you have regarding scholarship and the impacts it could have on you or your children’s tax returns.