The background:
- Scholarship amounts received by students during a tax year, that exceed the cost of tuition, books and fees, are taxed as unearned income to the student in that year.
- Scholarship amounts awarded to the student to specifically pay for room and board, are taxed as unearned income.
- The Good News. Most undergraduate scholarships do not include funds to pay for room and board or amounts in excess of tuition, books and fees, and are therefore not taxable.
- The Exception. Athletic Scholarships that are referred to as “full-ride scholarships” include funds to pay for room and board, as well as costs in excess of tuition, books and fees, and that portion of the scholarship is taxable to the student.
Q. What does this mean for the student?
A. The student is responsible for paying any federal and state income taxes on the income generated by the taxable portion of the scholarship. So, if the student receives $20,000 to cover their room and board costs, they must report the $20,000 as income and pay the tax on it. This means that the student must arrange for the funds necessary to pay all taxes.
Q. What has changed? Why is this a big deal?
A. The Tax Cuts and Jobs Act of 2017 changed the federal tax rates for taxable scholarships
Taxable scholarships are now assessed at the following rates:
10% up to $2,550
24% from $2,551 to $9,150
35% from $9.151 to $12,500
37% > $12,501
Q. What impact does this change make on students?
A. In the example above where the student received $20,000 to cover room and board, this creates $20,000 of taxable income and a federal tax of $5,786+/-. In some states there will be a state income tax as well. The student will need an additional $5,786 to pay the taxes.
Q. Who is affected by these changes?
A. The Associated Press recently reported that 1.3 million undergraduate students and 15,000 graduate students received taxable scholarships in 2018.
Q. What is the first step a student should take?
A. The student needs to do the following:
- Determine the amount and nature of all scholarships received during the tax year (January – December). Note that this is for the calendar year not the academic year.
- Calculate the amount paid for tuition, fees, books and supplies.
- Determine if they received amounts in excess of tuition, books and fees, or if a scholarship was specifically for costs other than tuition, books and fees. These amounts are taxable income to the student.
Q. What is the next step?
A. The student needs to determine if:
- They are required to file a federal and/or state income tax return or
- They must add the taxable scholarship to income reported on an existing tax return.
Observations:
In our experience, schools do a notoriously poor job of reporting taxable scholarships to students. Most schools that we are aware of make a token gesture in the form of a letter informing the student of the amount of scholarships received, with no attempt to explain how it may be taxed.
Remember, the student is responsible for determining if s/he received a taxable scholarship and if a federal and/or state income tax return is required to be filed. IRS Publication 970 is very helpful in providing guidance on how to calculate a taxable scholarship.
Over the past 3 decades I have observed that the average “tax preparer” does not understand taxable scholarships and will struggle to properly advise the student. Our recommendation is that the student contact a tax preparer who is very familiar with taxable scholarships, such as a CPA or an Enrolled Agent, in order to obtain sound advice on their tax filing requirements. Be sure to ask the tax preparer about their experience level of experience and familiarity with taxable scholarships
