Don't Mess With Taxes

Study up on ways to pay for your or your child's college costs. Some student aid, like scholarships, typically are tax free. (Photo courtesy On Campus Market/OCM.com blog)

Here in Austin, fall 2017 classes at the University of Texas will begin on Aug. 30. But students must meet another important deadline on Aug. 18.

That’s the day that UT tuition payments are due, either paid in full or in installments. It’s a scenario playing out across the United States.

And it’s one that is a growing challenge.

The College Board’s most recent survey of college costs found that a moderate budget for an in-state public college for the 2016–2017 academic year averaged $24,610. A moderate budget at a private college was just more than twice that, averaging $49,320.

In most cases, students and their families trying to cover the high cost of higher education depend on a variety of funding sources, from savings to loans and educational tax breaks and work-study programs to financial aid like grants and scholarships.

Welcome way to pay: Scholarships can be particularly welcome. There are thousands out there — just Google “college scholarships” or check with your university’s financial aid office — ranging from a few hundred to thousands of dollars.

They are awarded based on merit and need. Many have broad eligibility criteria and cover expenses from tuition and fees to room and board, books, transportation and miscellaneous items.

The first question scholarship recipients ask is how will this money affect other college aid? College policies vary, but in most cases these funds that don’t have to be paid back will displace other types of student financial assistance.

Typically not taxable: But there’s better news for another scholarship question: Is the scholarship money taxable?

Your scholarship, fellowship or grant generally is tax-free if the following two conditions are met:

1. You're working toward a degree, undergraduate or graduate, at an educational institution that maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance at the place where it carries on its educational activities. Basically, you're studying to get a diploma at a real school.
2. You use the amounts you receive to pay for tuition and fees required for enrollment or attendance at the educational institution, or for fees, books, supplies and equipment required for courses at the educational institution. Again, the quick answer is that the money goes toward obtaining that degree.

These tax rules apply to both merit and athletic scholarships, fellowships and grants, including government-sponsored, need-based Pell Grants.

Note, though, the Internal Revenue Service says a scholarship or fellowship grant is tax free only to the extent that it:

• Doesn't exceed your qualified education expenses,
• Isn't designated or earmarked for other purposes, such as room and board,
• Doesn't require (by its terms) that it can't be used for qualified education expenses, and
• Doesn't represent payment for teaching, research, or other services required as a condition for receiving the scholarship.

Opting/having to count it as taxable: While avoiding a tax bill on scholarship money is usually preferable, sometimes it might be worth counting the educational assistance as taxable income even if you don’t have to.

This could be the case if you qualify for an education tax credit. You may be able to get a larger credit by choosing to include some or all of the scholarship, fellowship or grant in your income.

And the IRS points out that some types of financial aid definitely are taxable. You must include in your gross income:

• Amounts used for incidental expenses, such as room and board, travel, and optional equipment.
• Amounts received as payments for teaching, research, or other services required as a condition for receiving the scholarship or fellowship grant. However, you don't need to include in gross income any amounts you receive for services that are required by the National Health Service Corps Scholarship Program or the Armed Forces Health Professions Scholarship and Financial Assistance Program.

The Interactive Tax Assistant tool on IRS.gov can help you check whether and/or how much scholarship money is or isn’t taxable.

Reporting the financial aid: When you do have to report as income any portion of a scholarship, a fellowship or other grant that you received, add the amount to the “Wages, salaries, tips” line of your 1040, 1040A or 1040EZ form.

If the taxable amount wasn't reported on a Form W-2, enter "SCH" along with the taxable amount in the space to the left of the "Wages, salaries, tips" line.

If you must file Form 1040NR or 1040NR-EZ, report the taxable amount on the "Scholarship and fellowship grants" line.

You can find more information the tax implications of scholarships and other education financial aid, as well as educational tax credits and other school-related tax breaks in IRS Publication 970, Tax Benefits for Education.

You also might find these items of interest:

• 529 plans' perks and pitfalls
• Scholarships and grants get better grades than borrowing
• IRS online data retrieval tool now available for certain student aid applicants