With students headed back to campus, college finances are on the minds of many parents. This includes parents of students who have received scholarships and grants. Obviously, these funds help relieve some of the burden of paying for college. But you might be wondering whether they’re taxable. The answer depends upon a number of different factors.
THE NUTS AND BOLTS
Scholarships and grants, including Pell Grants and Fulbright Grants, are generally treated the same from a tax perspective. If scholarship or grant funds are used by a degree-seeking student to pay for qualified education expenses at eligible education institutions, they aren’t considered taxable income. A degree-seeking student is an individual who is pursuing studies for an associate, bachelor’s or higher degree at an eligible education institution. And an eligible education institution is one that provides programs that can be used as full and acceptable course credits toward college degrees, or one that offers training preparation programs for students seeking gainful employment in recognized occupations. The institution also must have received a nationally recognized accreditation status. Qualified education expenses include tuition and fees, as well as course-related expenses (such as books, supplies and equipment) required in a student’s course of instruction. They don’t include room and board, however. To qualify, the expenses must be required of all students taking the particular course – they can’t be optional expenses that aren’t necessary to satisfy course requirements.
If scholarship or grant proceeds are used for any external purposes, the money is considered unearned income and subject to taxation. This includes money left over after all qualified education expenses have been paid. Of course, students can use this money for other purposes, such as to pay for room and board, utilities, groceries or meals eaten out. But they’ll have to pay tax on it when they file their income tax returns. It’s important to note that qualifying payments received through the Department of Veterans Affairs (including the GI Bill) generally aren’t taxable if used to pay for education or training. In addition, if a student receives payment for teaching, research or other services that are required as a condition of receiving the scholarship or grant, this money is generally considered taxable income. An exception is made, however, for services required by the National Health Service Corps Scholarship Program, the Armed Forces Health Professions Scholarship and Financial Assistance Program, and certain other programs.
POTENTIAL EFFECT ON THE “KIDDIE” TAX
Scholarships and grants could affect what’s referred to as the “kiddie” tax. This tax originally applied to children under 14 years old with unearned income, but the scope has progressively increased over the years, and it now may apply to college students. Specifically, the kiddie tax now applies to children who are claimed as dependents and are under 19 years old, or full-time college students between 19 and 23 years old who have at least one living parent, and aren’t married and filing joint tax returns with their spouses. When a college student meets this definition and has unearned income worth more than twice the standard deduction amount for a dependent – $2,500 in 2023 – he or she must complete IRS Form 8615 to determine how much tax is owed. The first $1,250 of unearned income will be off- set by the standard deduction, while the second $1,250 will be taxed at the student’s tax rate. Any unearned income above $2,500 will be taxed at the marginal tax rate of the child’s parent(s).
SEEK PROFESSIONAL ADVICE
Determining the tax treatment of college scholarships and grants can quickly become complicated. It’s wise to talk to a tax professional about your specific situation to ensure you cover all the bases.
Management & Tax Concepts Newsletter (Fall 2023)