Dear Carrie: Does my son have to pay taxes on his scholarships and need grants in college? -- A Reader
Dear Reader: I'm actually surprised this question doesn't come up more often, so thank you for raising it. For the most part, scholarship money is not considered income and is not, therefore, taxable. But as with most tax issues, a simple "yes or no" answer doesn't always apply. So, let's take a closer look.
According to the IRS (specifically, "IRS Publication 970," available online at IRS.gov), scholarships and fellowships are tax-free under the following circumstances:
-- Your son is a degree candidate at an eligible educational institution.
-- The scholarship or fellowship money is used for qualified expenses, which include tuition and fees, books and course- or degree-related costs (like supplies required for specific classes). This is important: Room and board, travel or other expenses associated with a college education are not considered qualified expenses and are therefore taxable. I'll revisit this idea below.
-- The money does not represent wages for teaching or other work. So if your son serves as a teaching assistant, a research or lab assistant or has some other kind of job, even if directly related to the degree being pursued, that money is taxable.
For example, if your son received a $5,000 scholarship and tuition was $10,000, he would owe no taxes on the scholarship; the entire amount would be devoted to the qualified expense of tuition and fees. On the other hand, if he had a $15,000 scholarship and used $10,000 for tuition, $1,000 for books and $4,000 for room and board, then the $4,000 would be taxable income. Colleges are not required to report scholarship or fellowship income to the IRS, so it's up to your son to understand the rules and account for the money appropriately on his tax return.
However, scholarship or fellowship money that represents compensation is taxable. Let's say your son is a grad student with a fellowship worth $20,000 that requires him to be a teaching assistant or a research assistant. Some portion of that $20,000 will be considered compensation for services, and he'd receive a W-2 form from the university. That amount is taxable income, regardless of how the money is used. In other words, even if the entire portion that represents compensation goes to tuition and other qualified expenses, the IRS considers it income -- he'd be liable for taxes on that income.