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Understanding the Difference Between Taxable and Tax-Free Scholarships

Scholarships, unlike loans, do not require repayment and, therefore, help ease the college debt burden on students and parents. But, are scholarships taxable income? The answer depends on what the scholarship will be used to cover – educational vs. living and other expenses or required vs. non-required supplies

What are the IRS scholarship rules?

According to the Internal Revenue Service (IRS), a scholarship is an amount paid or allowed to, or for the benefit of, a student (undergraduate or a graduate) at an educational institution to aid in the pursuit of his or her studies. But that could mean it helps pay for tuition, room and board or travel expenses, books and other supplies – right? The IRS says yes, but depending on which expenses the scholarship funds cover, the award may be considered taxable income.

Here’s a brief breakdown on IRS scholarship rules:

  • A scholarship is tax-free if:
    • You (or your child) are a full- or part-time degree candidate at an accredited college or university.
    • The scholarship award covers tuition and fees to enroll at and/or attend that institution.
    • And/or the award covers course-required fees, books, supplies and equipment.
  • Scholarship money is taxable if it covers any of the following:
    • Room and board
    • Travel
    • Research expenses
    • Fees, books, supplies and equipment not required for courses

What if you use the scholarship money for more than one thing?

If you’ve received a scholarship and plan to use it for tuition, as well as room and board or for required and/or non-required supplies or equipment, only the amount you use for tuition or qualified supplies will be tax-free. However, the amount you use to cover taxable expenses will need to be reported on your return. Sound confusing? Luckily, there are resources that can help. Visit the IRS site section on tax benefits for education and use this tool to learn which award amounts you should report.

Are there exceptions?

IRS rules apply to most awards – whether they’re merit-based, athletic, government-sponsored or grants; however, there are a few exceptions. Payments made through the GI Bill are not considered taxable income. If you’re participating in the National Health Service Corps Scholarship Program or the Armed Forces Health Profession Scholarship and Financial Assistance Program, you do not have to pay taxes on your aid. And student loans, which are not considered scholarships or income – as they have to be repaid, are never taxable.

If you’ve already received a scholarship or two – congratulations! If you’re still in the application stage, avoid these seven big mistakes to improve your chances of earning an award that can help offset all your college costs. 

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