It's tough to think of a bad thing about getting a college scholarship, but one could be its impact on your taxable income. As with many tax questions, the answer here is "it depends." The source of the money, how it's spent and whether you're getting a degree determines how much might be taxable. You don't have to report non-taxable scholarship income on your tax return.
If you're pursuing a degree, the portion of your scholarship money used for tuition is not taxable. The Internal Revenue Service can be a little picky with these definitions, but a few general rules do apply. If you're pursuing a bachelor's degree or higher, or in a training program for a recognized occupation, and it's a nationally accredited institution, it qualifies.
Eligible Educational Expenses
Scholarship money spent on something required for your actual education is not usually taxed. Tuition, fees and book expenses are all OK with the tax man. The same can't be said for room, board and general living expenses. The IRS also can be picky about you attempting to deduct anything considered optional, even if you consider it necessary. For example, a computer may seem vital to your educational pursuits. However, unless the school demands everyone in your degree program get one, scholarship money spent on a computer is taxable.
Uncle Sam wants you to save money on taxes if you spent some time serving your country. Any money you get from Department of Veterans Affairs for education is tax free, no matter how it is used, even for room and board. Scholarships through the National Health Service Corps Scholarship Program, or the Armed Forces Health Professions Scholarship and Financial Assistance Program, are also non-taxable.
Taxable Income Benefits
If any portion of your scholarship is considered taxable income, and it's reported on a W-2, you can contribute to an individual retirement account for that year. Some people are lucky enough to have money left over after paying for tuition and books. If you're one of them and want to reduce possible tax liability, this is a way to get a head start on your retirement nest egg. The contribution is a tax deduction, and the investment grows tax deferred until you retire.
If you apply for the American Opportunity Credit or other education credits, you can't claim expenses paid by your scholarship windfall. If you spent $10,000 on tuition, books and the like, but got a $6,000 scholarship, the amount of AOC you get is based on the remaining $4,000 of eligible expenses for the year.
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