Are scholarships taxable income? 4 times when they are.

Young Hispanic college student wonders "Are scholarships taxable income?"Image: Young Hispanic college student wonders "Are scholarships taxable income?"

In a Nutshell

A scholarship isn’t just a source of funding for college — it’s also a point of pride. So it can be disheartening to learn that your achievement may actually be taxable. Here’s the 411 on when and how scholarships may be taxed.
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This article was fact-checked by our editors and Christina Taylor, MBA, senior manager of tax operations for Credit Karma.

Scoring a scholarship is great news — for your wallet and your self-esteem.

Getting a scholarship can help you reduce the amount you may have to borrow to pay for college, or even avoid student loans altogether. Plus you can be proud of any academic or athletic accomplishments that led to the scholarship.

But if the money is taxable, you could end up stuck with a large tax bill to boot. Here’s what you need to know if you’re wondering, “Are scholarships taxable income?”

Typically tax-free

Generally, scholarship money is tax-free if it meets the following requirements:

  • You’re pursuing a degree at an eligible educational institution.
  • You use the scholarship or fellowship to pay qualified education expenses.
  • The scholarship funds aren’t more than you’ll need for qualified education expenses.
  • It’s not designated or earmarked for other purposes — for example, room and board — and doesn’t require that you use it for non-qualified education expenses only.
  • It’s not considered payment for teaching, research or other services.

It doesn’t matter who awarded you the scholarship, and you can even take advantage of the tax-free status if you’re attending school overseas.

What counts as an ‘eligible educational institution?’

In order to be tax-free, scholarship money must be spent at an “eligible educational institution.” For tax purposes, the IRS considers an eligible educational institution to …

  • Be primarily engaged in presenting formal instruction
  • Maintain a regular facility and curriculum
  • Have a regularly enrolled student body attending the facility where the instruction occurs

4 times when scholarships could be taxed

If your scholarship doesn’t meet one or more of the above requirements, you could be on the hook to pay taxes on some or all the money you received.

Specifically, here are four times a scholarship is considered taxable income.

1. Your school isn’t eligible, or you’re not pursuing a degree

An eligible education institution meets the following requirements:

  • It offers higher education beyond high school.
  • It’s eligible to participate in a student aid program through the U.S. Department of Education.

Most accredited public, nonprofit and private for-profit universities are considered eligible education institutions. To make sure yours is on the list, check out the Database of Accredited Postsecondary Institutions and Programs. It’s possible, however, that your school is eligible but isn’t on the list, so it may be a good idea to check with your school directly.

“The school should be able to confirm if it is an eligible educational institution for these purposes,” says Josh Hanover, an enrolled agent and senior manager at accounting firm Marks Paneth LLC.

Additionally, the IRS requires that you be a candidate for a degree. So if you’re just taking classes for fun or aren’t eligible for a degree for any other reason, any scholarship money you receive is taxable.

2. The funds exceed your qualified education expenses

According to the IRS, only tuition, fees, and other expenses that are required to enroll or attend school count as qualified education expenses.

The following don’t count as qualified expenses for tax-free scholarship purposes:

  • Rent
  • Groceries
  • Insurance
  • Medical expenses
  • Transportation
  • Other similar living expenses

That said, if only part of your scholarship funds exceeds your qualified education expenses, only a portion is taxable.

So if, for example, you receive a $10,000 scholarship but the cost of tuition, fees and other expenses at your chosen school only totals $9,000, the remaining $1,000 of your scholarship would be considered taxable income.

3. The funds are earmarked for nonqualified expenses

If you receive a scholarship specifically for nonqualified expenses, the amount earmarked for those purposes is considered taxable.

For example, if you’re a student athlete, you likely don’t have a lot of extra time to get a part-time job. As a result, your college may offer an athletic scholarship that includes funds earmarked for both tuition and room and board.

In this scenario, the funds designated specifically for room and board are considered taxable income if the scholarship requires you to use the money for that purpose.

4. The funds are considered payment for services

If you’re required to offer some kind of service as a condition to receive your scholarship, the money you receive is considered taxable.

For example, let’s say you receive a $2,000 scholarship for tuition, but you can get an extra $1,000 if you work part-time as a teaching assistant at the college or university. If you take the offer, $2,000 of the money you receive is tax-free, but you’ll receive a W-2 showing the extra $1,000 as taxable income.

The same also applies if you’re required to perform future services to get the scholarship. So double-check in advance to see if there are any such stipulations or caveats.

Part of any scholarship or fellowship you receive as a result of any of the following programs is considered an exception to this rule:

  • The National Health Service Corps Scholarship Program
  • The Armed Forces Health Professions Scholarship and Financial Assistance Program
  • A comprehensive student work-learning-service program (as defined in section 448(e) of the Higher Education Act of 1965) operated by a work college (as defined in that section)

The federal government allows multiple tax breaks related to higher education …

Bottom line

As a college student, the last thing you want is to use all your scholarship money only to find out later that you should’ve set aside some of the funds to pay taxes. As a result, it’s critical to know whether scholarships are taxable income before you accept them so that you can properly plan and improve your chances of getting a tax refund.

Relevant sources: Tax Benefits for Education: Information Center | IRS Publication 970: Tax Benefits for Education | IRS: What is an Eligible Educational Institution? | IRS: Qualified Education Expenses

Christina Taylor is senior manager of tax operations for Credit Karma. She has more than a dozen years of experience in tax, accounting and business operations. Christina founded her own accounting consultancy and managed it for more than six years. She co-developed an online DIY tax-preparation product, serving as chief operating officer for seven years. She is the current treasurer of the National Association of Computerized Tax Processors and holds a bachelor’s in business administration/accounting from Baker College and an MBA from Meredith College. You can find her on LinkedIn.

About the author: Ben Luthi is a personal finance freelance writer and credit cards expert. He holds a bachelor’s degree in business management and finance from Brigham Young University. In addition to Credit Karma, you can find his wo… Read more.