Paying for college isnโt getting any cheaper, so in order to avoid going into unaffordable education debt, families and students either need to save more money, go to less expensive schools or find someone else to pay for it.
There are hundreds of thousands โ maybe even millions โ of scholarship opportunities out there, but receiving monetary awards can do more than affect your financial aid situation. It may also affect your taxes.
Defining โScholarshipโ
Whether or not a scholarship is taxable depends on a few things, mostly on how you receive it. A lot of schools give students discounts on tuition and fees and call it a scholarship, but the institutions arenโt really giving students money to help pay for school; theyโre just charging them less.
That sort of scholarship isnโt taxable, said Elliott Freirich, a certified public accountant in Chicago. It sill affects the scholarship recipientโs taxes, because reduced tuition may mean a reduced amount of education credit he or she can claim.
If a school is actually giving you money, that changes things. Such a situation often comes up in graduate programs, when students sometimes receive stipends for work they do at the university or to cover living expenses during a demanding, time-consuming program. Stipends are taxable and should be reported as Form W-2 income, Freirich said. In his experience, however, that doesnโt always happen.
โUniversities often screw up how itโs reported,โ he said. โIn some cases, they have reported it as self-employment income, which means the student is going to have to pay both halves of Social Security and Medicare on that income.โ Heโs also encountered students who didnโt receive any tax forms from their universities โ just letters stating the stipend amount โ and itโs up to the student to figure out the tax part.
โI would ask for a tax document first,โ Freirich said. โAsk for some kind of official documentation from the school, and if the school doesnโt know โฆ find a good CPA to help you.โ
How to Handle Checks
Sometimes, a scholarship program will dole out awards by paper check directly to its recipients. From a tax perspective, there are two things to consider when you receive a scholarship: What youโre using it for and how youโre receiving it. If you use the money to pay for tuition, fees books, supplies or equipment required for enrollment at your institution, the scholarship is tax-free. Itโs paying for optional expenses (anything youโre not required to pay for in order to be enrolled) when your scholarship would be subject to taxes.
If you receive and deposit the check, and you use the funds to pay for optional education-related expenses, you are required to claim that check as taxable income, Freirich said. However, if the scholarship program sends the payment directly to the school, essentially paying on your behalf, you never receive that money and do not pay taxes on it.
โThe school just issues a document called a 1098-T, and it shows how much is paid for tuition and how much is a scholarship, but it doesnโt say โThis much was for room and board and is taxable,'โ Freirich said. (Room and board can get tricky with scholarships, because if itโs not required for enrollment, it could be considered an incidental expense and subject to taxes). The key here is to communicate with the scholarship provider and make sure you understand how the funding will be delivered.
Scholarships are a fantastic resource for students looking to reduce how much they pay for their educations. Theyโre generally quite competitive, which is why financial aid experts often recommend applying for as many as you can and treating the scholarship search-and-application process like a job. The less of your education you have to finance with student loans, the better, because while student loans are a good resource for making higher education attainable for people of various financial backgrounds, the debt can be a serious, lifelong burden if itโs mismanaged. Student loan debt can generally not be discharged in bankruptcy, and falling behind on loan payments will destroy the borrowerโs credit for years. You can get a free credit report summary on Credit.com to see how your student loans are impacting your credit.
(This story was updated to clarify the tax implications when scholarship checks are sent to students and used for required versus optional education related expenses.)
More on Income Tax:
- How to File Your Taxes for Free
- Do Unpaid Taxes Affect Your Credit Report?
- Do Taxes Affect Your Credit Score?
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