When scholarship money counts as income

Use this page to sort your scholarships and grants into the part the IRS treats as tax-free and the part it may treat as income. The answer depends on what the money paid for, so have your award letters and your school bill in front of you.

The tax-free part

A scholarship or grant is generally tax-free when you are a candidate for a degree and the money pays for tuition, required fees, and the books, supplies and equipment your courses require. Federal grants such as the Pell Grant follow the same rule. The test is how the money was used, whatever the award is called.

Students taking courses outside a degree program, such as classes for personal interest, generally owe tax on the whole award. Ask the school whether your enrollment counts as degree study if you are unsure.

The part that can be taxable

Money used for room and board, travel, or optional equipment generally counts as income. So does any part of an award paid in return for work, such as teaching or research the school requires as a condition of the money. Some service-linked programs have their own exceptions, and Publication 970 lists them.

This often surprises students whose grants exceed tuition and come back as a refund for living costs. Receiving the refund is routine, but the IRS may treat that portion of the award as taxable income for the year.

Gather these first

• Award letters for every scholarship and grant
• Form 1098-T from your school
• Your bill showing tuition and fees
• Receipts for required books and supplies

Working out your own split

Start with the total of scholarships and grants for the year, from your award letters and Box 5 of Form 1098-T. Subtract tuition, required fees and required course materials. What remains is roughly the amount that may be taxable, though awards that cross calendar years can shift it.

Taxable scholarship money belongs on your federal return even when no form shows it as income. It can also raise your income enough that you need to file. A VITA site can help you work through the numbers, since this question comes up there often.

How it interacts with the credits

Expenses paid with tax-free scholarship money cannot also count toward an education credit. In some cases a student can choose to treat part of a scholarship as taxable, which frees up tuition to count toward the American Opportunity credit. Run the numbers both ways with a preparer before deciding.

This choice works only when the award's own terms allow the money to be spent on living costs, so a scholarship restricted to tuition cannot be split this way. It can also change what a parent claims if you are a dependent, and Publication 970 sets out the details.