If you receive financial aid to pay for your - or your child’s - college education, then you may be wondering if you need to pay taxes on that money. The short answer is maybe. It depends mostly on the type of financial aid you receive and how the money was spent. Students are frequently able to avoid paying any taxes on financial aid monies received, but it is important to understand the tax ramifications of obtaining financial aid before accepting any student assistance packages.
What are the Enrollment Requirements?
Students who receive financial aid but are not enrolled in a degree program at an eligible educational institution are obligated to pay taxes on the full amount of financial aid that they receive (excluding loans, which are always tax-exempt). Students may be enrolled either part-time or full-time to be eligible for tax exemptions.
What are Qualifying Expenses?
Several types of financial aid are tax-exempt, provided that the money is spent on tuition or required course-related expenses, such as student activity fees, books, supplies, and necessary equipment. Room and board, travel costs, and other education-related expenses are not qualifying expenses according to the IRS.
What Types of Financial Aid are Tax-Exempt?
Financial aid may take the form of grants and scholarships, work-study positions, or student loans. For tax purposes, the IRS treats each type of financial aid slightly differently:
Grants & scholarships: Provided that the money is spent on qualifying expenses, grants and scholarships are tax-exempt. A student is only required to pay taxes on the portion of a grant or scholarship that is used to pay for non-qualifying expenses. (Some scholarships are specifically earmarked for non-qualifying expenses, such as room and board, and therefore are 100 percent taxable.) FICA taxes are never assessed on grant or scholarships, even for students enrolled in non-degree programs. Notably, if a scholarship (or fellowship) is awarded as compensation for teaching or research services provided by a student, then the portion of the award representing payment for services (usually calculated as the amount exceeding the cost of tuition) is subject to taxes. Certain types of scholarships with service components, such as ROTC scholarships, are however exempt from this tax code provision.
Work-study positions: Because work-study positions pay wages just like any other job, the IRS treats work-study earnings as taxable income. However, work-study income is not subject to FICA taxes, provided that the work occurs on campus or you are enrolled in at least six credit-hours per semester. Income from certain work-study positions, such as those sponsored by the National Health Service Corps Scholarship Program and the Armed Forces Health Professions Scholarship Program, is completely tax-exempt.
Student loans: Since student loans must be repaid in full, with interest, the money received from student loans is never treated as taxable income. However, if you are granted loan forgiveness at a later date, then you may be required to pay income tax on the portion of the loan that is forgiven.
How Do I Report My Financial Aid to the IRS?
Other than for work-study positions, the IRS does not receive a 1099 or W-2 form for your financial aid money. It is incumbent on you to correctly report the taxable portion of your grants and scholarships. (And make sure you do, too! The FAFSA includes a question about the amount of grant and scholarship aid that you reported as income to the IRS for the relevant tax year.) The taxable portion of your financial aid is reported on Form 1040 as part of your Adjusted Gross Income. During the years that you attend school, you can likely qualify for one of two education tax credits offered by the IRS, the Lifetime Learning Credit and the American Opportunity Education Credit. In addition, the Student Loan Interest Deduction is available to most borrowers once their loan repayment terms begin.