Are Scholarships Tax-Free?

Many not-for-profit organizations offer grants to individuals in the form of scholarships. Typically awarded on the basis of academics, achievement or need, scholarships are designed to help to support a student’s education. When accepting a scholarship, it is important for students to understand when it is excludable from the recipient’s taxable income, as opposed to other forms of remuneration that might have tax consequences.

Scholarships are generally tax-free to an individual provided all of these conditions are met:

• The recipient is a candidate for a degree.
• The educational institution maintains a regular faculty and curriculum and normally has a regularly enrolled body of students in attendance where it conducts its educational activities.
• The amounts received are used to pay “qualified educational expenses.” These include tuition, enrollment and attendance fees, books, supplies, and equipment required for courses at the educational institution.

Scholarships are taxable and included in the recipient’s gross income when (1) The amount is used for incidental expenses, room and board, travel, and so forth; or (2) The amount is received for which teaching, research or other services are required as a condition for receiving the scholarship. In this case, the organization may issue a Form W-2 to the recipient for the taxable portion related to services rendered.

It is important to understand which expenses are qualified educational items so that you do not wind up with unintentional taxable scholarship income.